Chapter 9

1. Chapter 9 International Segment Reporting

2. 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

3. 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

4. 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

5. 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 International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

6. 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 International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

7. 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

8. 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

9. 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 International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

10. 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

11. 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

12. 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

13. 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

14. 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

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

16. 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

17. 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

18. 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 International Accounting and Multinational Enterprises – Chapter 9 – Radebaugh, Gray, Black

19. 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

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

21. 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