International Segment Reporting Chapter 9 International Segment Reporting

Users and Uses of Segment Information Diversification of operations leads to the need for segment information Segment data is typically provided for geographical areas and lines of business Segment information allows the following Investor combination of company-specific information with external information More accurate assessment of risks More accurate assessment of growth potential International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Users and Uses of Segment Information Segment information is also valuable to employees, creditors, and host governments Questions associated with segment reporting Do the benefits exceed the costs? Is regulation necessary? If so, what form should regulation take? How should segments be identified? What should be the content of segment reports? How should items disclosed be measured and presented? International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

The Benefits of Segment Reporting Tested by two methods Predictive ability tests Compare accuracy of forecasts of future sales or earnings based on consolidated data to those based on disaggregated data Assumes that useful information is any information that helps predict earnings Stock market reaction tests Shows that if the stock market reacts to information, the information must be useful If the information has no effect, it is irrelevant or has already been obtained through another source International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

The Benefits of Segment Reporting Predictions are more accurate if based on line-of-business (LOB) segmental data Forecasts based on segment earnings are more accurate than those based on segmental turnover in the U.S. Segmental information for small companies may be more accurate Research finds similar findings for geographical segment disclosures Do I need a citation for the fourth bullet? International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

The Benefits of Segment Reporting Inconclusive research exists on the effects of LOB and geographical segment data on risk assessment in relation to stock market studies Do I need a citation here? International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

The Costs of Segment Reporting Cost may be low because of the existing information infrastructure of the company Companies may provide competitors with sensitive information This kind of disclosure may benefit countries operating in one industry or country rather than multisegment MNEs Interdependence of segments may limit effectiveness of segment reporting International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

International Financial Reporting Standards IAS 14 “Segment Reporting” (1997) Company’s organizational structure serves as the basis for reporting segments “Primary” segment reporting format has more disclosure than “secondary” segment If risks and returns are affected by LOB and geographical segments, business segments should be used as the primary format “Matrix” presentation with disclosures on each basis is allowed If neither approach is reflected in the organizational structure, one should be chosen as the primary format Reportable segments exist where a majority of revenue is earned from external customers and segment revenue is 10% or more of total revenue International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Regulations Around the World U.S. requirements SFAS 131 (replacing SFAS 14) Similar to IAS 14 Reportable segments based on LOB, geographic location, or a combination of both Enterprise-wide disclosures (“second tier” reporting) include Country of domicile Any individually material country All foreign countries in the aggregate Aggregate information by continent or geographic area groupings is no longer permitted Profit disclosure is not required in “second tier” reporting Nichols, Street, and, Gray, 2000 International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Regulations Around the World U.K. requirements Companies Acts of 1981 and 1989 Requires disclosure of geographical segment turnover and LOB disclosure of sales Any market or class of business deemed “immaterial” may be combined with another A definition of a reporting segment is not given International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Regulations Around the World U.K. requirements SSAP 25, Segmental Reporting by the ASC Requires disclosure of segment net assets for LOB and geographical segments Geographical segmentation of sales is required by source and destination Geographical and LOB segmental profit disclosure are required International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Regulations Around the World Requirements in Other Countries Australia and Canada have requirements similar to those in the U.S. and the U.K. EU countries have minimum disclosure requirements Most European countries have a more secretive approach Japan has requirements consistent with IAS International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Segment Reporting Problems Segment identification Difficulties arise in auditing because there is no clear-cut definition Example – some companies define Europe, the Middle East, and Africa as one segment Comparability has been sacrificed for relevance Management determination of segments implies that what is useful to management is useful to investors Common costs are likely to be allocated, bringing segment information into question International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

The Dual-Yardstick Approach (Emmanuel and Gray, 1978) Industry/geographical groupings are related to an external standard industrial classification Requirements for an organizational unit More than 50% of physical sales value is sold externally Revenue and profitability information is accumulated regularly for this unit Responsibility for the unit’s operating performance resides with the immediate manager of the unit International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Dual Yardstick Approach International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

The Dual-Yardstick Approach Other desirable information includes Management responsibilities Organization structure Volume of internal transactions Benefits of other desirable information Facilitated auditor verification of the quality of segmental disclosures Indication of corporate strategy International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

The Dual-Yardstick Approach Maintains a balance between the use of managerial discretion and an inflexible classification system Provides meaningful segments for external users Realistic, material segments are identified International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

International Issues Emmanuel and Gray suggest that organizational structure should be the primary yardstick Disclosure should be made consistent with geographical areas considered significant by management Disclosure should be consistent with risk-return perceptions Geographical locations should not be mixed up with markets served from such locations Management is given a lot of discretion Do I need the year in the first bullet? International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

International Issues Application of the 50% rule can become more complicated An auditor’s task is important in this case An auditor is responsible for evaluating Meaningfulness of segmental disclosures Risk factors involved Organization of responsibilities to match international activities International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Dual Yardstick Approach International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

Matrix Presentation Many companies provide LOB and geographical segmental data separately instead of in matrix form Matrix form gives information on the interrelationship of the two types of segments Makes a more accurate assessment of business prospects possible International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black