As part of its activities, the European Securities and Markets Authority (ESMA) organizes a forum of enforcers from 38 different European jurisdictions, all of whom carry out monitoring and review programs similar to those carried out here by the Canadian Securities Administrators. ESMA recently published some extracts from its confidential database of enforcement decisions on financial statements, covering twelve cases arising in the period from December 2020 to January 2023, with the aim of “strengthening supervisory convergence and providing issuers and users of financial statements with relevant information on the appropriate application of IFRS.” There’s no way of knowing whether these are purely one-off issues or more widespread, but some of them certainly have some relevance to matters discussed within Canadian entities once in a while. Here’s one:

• The issuer is a confectionery company. Its products are divided into two categories. In its segment reporting note, the issuer identified five operating segments: “Country A”, “Country B+C”, “Country D”, “Country E+F” and “Country G & International”. In its 2019 annual report, the issuer aggregated the five operating segments into one reportable segment and therefore did not separately disclose the information required by IFRS 8 for each operating segment.
• The issuer’s decision to aggregate the five operating segments into one reportable segment was based solely on the qualitative criteria a) – e) set out in paragraph 12 of IFRS 8. The issuer considered that these criteria were met, taking into account the following considerations:
  • the nature of sugar and chocolate confectionery, pastilles, nuts and chewing gum products was similar, which together form the concept of products for inexpensive cold snacks between main meals,
  • the nature of the production process was similar and centrally managed, facilitating the concentration of the production facilities and achieving economies of scale and cost efficiency,
  • the types of customers for the issuer’s products were similar. Traditional market segmentation based on age, gender, income, etc. is of little relevance to brand positioning in the confectionery market,
  • in all main markets, the issuer had its own sales and distribution organization, and
  • the regulatory environment for food was comparable across the issuer’s markets and, therefore, was not a relevant criterion for the issuer.
• While the long-term average gross margin in each operating segment differed up to approximately 20%, the EBIT margin differed up to approximately 15% and the net sales volume differed up to approximately 115 MEUR (which was material for the issuer). The issuer disregarded the requirement of paragraph 12 that the aggregated segments should have similar economic characteristics.
• In this respect, the issuer considered that the quantitative criterion related to average gross margin was not relevant to its type of business because this indicator for each individual operating segments was impacted by the mix of the issuer’s product categories.

The enforcer (as ESMA likes to term it) concluded that the issuer’s aggregation of operating segments didn’t meet the requirements of IFRS 8, and required the issuer to present several segments in its segment information note within the financial statements (the report doesn’t specify whether this means all five segments, or whether aggregation was accepted for some of them). As a reminder, the cited paragraph of IFRS 8 says that two or more operating segments may be aggregated into a single operating segment “if aggregation is consistent with the core principle of this IFRS” (that is, to disclose information enabling users to evaluate the nature and financial effects of the business activities in which the entity engages and the economic environments in which it operates), if the segments have similar economic characteristics, and if they’re similar in the five “qualitative” respects addressed above. Maybe it’s tempting for some to think that the words about “similar economic characteristics” are just noise, and that if two segments are similar enough in each of the five respects, it follows that aggregation would be appropriate. But on the contrary, while the nature of the products offered by two segments may seem “similar” in some general respects, the fact of them having (say) recurringly dissimilar gross margins would speak more loudly regarding their economic distinctiveness.

The example illustrates how malleable those qualitative criteria are: for instance, a bar of chocolate and a bag of nuts may be similar in some quick-hit snack-food sense, but not at all in others (if you’re craving a Mars Bar, a bag of unsalted peanuts probably won’t hit the mark). Anyway, I’ll make the same point I’ve made before, that rather than bothering to save such companies from their own eccentricity, I sometimes think the enforcer should offer the entity an alternative, of continuing to omit the disclosure, while prominently and frequently reminding users that they’ve done so. If users indeed don’t consider the information relevant, then no harm would be done. Or on the other hand, they might respond in a way that gives the company something to chew on, by looking elsewhere for more transparently sweeter investment opportunities…

The opinions expressed are solely those of the author.