International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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chemical compounds that are mixed together in batches to create the end product. Both products undergo
quality control testing in order to confirm the efficacy of the product. Both products also use the same
manufacturing equipment for parts of the production process. Thus, Life Co. concludes that for the purposes
of the segment aggregation criteria, the production processes are similar, despite the differences in the
applications of the end products.
(c) The type or class of customer for their products and services. Factors to consider
in evaluating whether the type or class of customer are similar include: (1) the
region or geography in which the products and services are marketed; (2) the
methods used to market the products or services, including the use of a common
or interchangeable sales force; and (3) the nature or type of customer including the
industries in which the customers may operate. Entities should carefully consider
whether this criterion has been met when the products or services of one operating
segment are targeted to a different customer base or constitute a material revenue
stream. Consider the following example:
Example 32.4: Type and class of customer
Market Co., a diversified clothing manufacturer has two operating segments, Retail and Wholesale. Retail
primarily markets its products to consumers through electronic and print advertising. In contrast, Wholesale
principally markets its products through a network of sales representatives who call upon the distributors to
purchase the products. In considering the type or class of customer, Market Co. concludes that the type and
class of customer are not similar for the two operating segments based upon the distinction between retail and
wholesale as well as the primary marketing methods for its products. As such, aggregation of the two
operating segments would not be permitted.
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(d) The methods used to distribute their products or provide their services. The
determination of whether two methods of distribution are similar will depend on
the structure of a particular company. Consider the following example:
Example 32.5: Retail outlets and internet distribution
Software Co., a software retailer, has two operating segments: Retail, which distributes its products through
retail outlets, and Internet, which distributes its products through a website on the internet. In evaluating
whether these operating segments can be aggregated, Software Co., might conclude that the methods to
distribute its products are not similar because Retail and Internet distribute products through different
distribution channels.
(e) If applicable, the nature of the regulatory environment, for example, banking,
insurance, or public utilities. Entities that operate within certain industries may be
subject to regulatory requirements that are promulgated by a government agency.
Sometimes two operating segments may produce the same product through the
same production process, but because of differences in the class of customer and
the regulatory environment, the operating segments should not be aggregated. For
example, it may not be appropriate for an entity to aggregate an operating segment
that produces a product under government contracts together with an operating
segment that produces the same product for commercial purposes.
Some entities are comprised of operating segments that operate within different
regulatory environments. We believe that the nature of the regulatory
environments in which two or more operating segments operate can be regarded
as similar, even if the regulatory bodies are not the same.
The following example illustrates how the management of an entity has interpreted
these requirements. However, any judgments to be made will be specific to the entity
and the environment in which it operates and in different circumstances some of the
characteristics considered will be relatively more or less relevant than others.
Example 32.6: Aggregating internally reported operating segments with similar
characteristics into a single reportable operating segment
In the information presented to the executive directors, a single-product company has identified seven
components of its business that are internally reported operating segments, Africa, Australia and Pacific,
France, Germany, Italy, UK and Ireland and USA. The company dominates its markets in Australia and
Pacific and in Germany and consequently enjoys superior operating profits. Its other markets are fragmented,
competition is greater and therefore historic and expected margins are lower. Can any segments be aggregated
for external reporting purposes?
Management has considered each of the criteria set out in paragraph 12 of IFRS 8 to determine whether the
economic characteristics of these separate operating segments are similar, including competitive and
operating risks, currency risks and political conditions, as well as current performance and future trading
prospects In these circumstances, management decided that it would not combine operating segments with
different underlying currency risks and regulatory environments. That left only France, Germany and Italy as
candidates for combination, since they all operate within the Euro zone. However, Germany has not been
included in a larger reportable segment because, whilst similar in all other ways, its long-term financial
performance is not expected to be comparable to France and Italy, as evidenced by its superior operating
profits. On this basis, management decided to aggregate only its operations in France and Italy for external
segment reporting purposes.
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As can be seen in the above example, operating segments trading in clearly different
economic environments (for example with unrelated functional currencies) should not
be aggregated for segment reporting purposes (unless they are so small as to fall within
the ‘all other segments’ category discussed at 3.2.4 below). The Standard states that the
existence of similar long-term average gross margins would be a positive
indicator. [IFRS 8.12]. This implies that operating segments should not be aggregated if
their long-term average gross margins are significantly different, even if they are similar
in all the other respects noted above. While IFRS 8 includes long-term gross margin as
an example of similar economic characteristics, if the CODM uses a different measure
of profit or loss (e.g. EBITDA) to assess performance and allocate resources to each
operating segment, that measure of profit or loss should also be considered when
assessing whether operating segments possess similar economic characteristics. In
addition, if other economic measures are provided to the CODM, the similarities of
those economic measures should also be considered. For example, if the CODM uses
sales metrics, return on investment, or other standard industry measures, those metrics
may also be relevant in determining economic similarity.
In assessing whether long-term average gross margins (or the appropriate measure of
operating performance used by the CODM to assess performance and allocate
resources, such as EBITDA) of operating segments are sufficiently similar, companies
should look to past and present performance as
indicators that segments are expected
to have the same future prospects. In other words, if operating segments do not
currently have similar gross margins and sales trends but are expected to have similar
long-term average gross margins and sales trends, it may be appropriate to aggregate the
two operating segments (provided all other criteria are met). Conversely, if operating
segments happen to have similar gross margins or sales trends in a given year but it is
not expected that the similar gross margins or sales trends will continue in the future,
the operating segments should not be aggregated for the current-year segment
disclosures just because current economic measures happen to be similar. It follows that
operating segments that have been profitable over the longer term should not be
combined with segments that over the longer term have been consistently loss-making.
IFRS 8 does not define the term ‘similar’ and does not provide guidance about what is
similar for aggregation purposes. As the above discussion indicates, the determination
of whether two or more operating segments are similar requires judgment and is
dependent on the individual facts and circumstances.
In a response to a submission in 2011, the Interpretations Committee had acknowledged
that IFRS 8 could usefully include further guidance on the meaning of ‘similar economic
characteristics’ and the criteria for identifying similar segments listed in (a) to (e) above.4
In a move to improve the Standard in this area, the IASB decided to enhance the
disclosures on the aggregation of segments but not to add any further guidance at that
time (see 5.1.1 below). More recently, the IASB intended to include further examples of
similar economic characteristics a result of its Post-implementation Review. However,
it has now decided not to amend IFRS 8 (see 7 below).
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3.2.2
Quantitative thresholds – operating segments which are reportable
because of their size
IFRS 8 includes a number of quantitative measures for determining whether
information on the identified operating segments should be reported separately.
Accordingly, an operating segment (or combination of segments meeting the qualitative
criteria for aggregation described at 3.2.1 above) merits separate disclosure if it meets
any of the following thresholds:
(a) its reported revenue (including both sales to external customers and intersegment
sales or transfers) is 10% or more of the combined revenue (internal and external)
of all operating segments; or
(b) its reported profit or loss is, in absolute terms, 10% or more of the greater of:
(i) the combined profit of all operating segments that did not report a loss; or
(ii) the combined loss of all operating segments that reported a loss; or
(c) its assets are 10% or more of the combined assets of all operating segments.
[IFRS 8.13].
The definition of an operating segment includes a component of an entity earning
revenues and incurring expenses relating to transactions with other components of the
same entity. [IFRS 8.5]. Therefore an entity would have to report separately information
on an operating segment that exceeds the above criteria, even if that segment earns a
majority of its revenues from transactions with other components of the same entity.
Example 32.7: Identifying reportable segments using the quantitative thresholds
An entity divides its business into 9 operating units for internal reporting purposes and presents information
to the Chief Operating Decision Maker as follows:
Unit
1
Unit 2 Unit 3 Unit 4 Unit 5 Unit 6
Unit 7
Unit 8
Unit 9
Total
£000
£000
£000
£000
£000
£000
£000
£000
£000
£000
Revenue:
External
34,000
3,000 15,000 30,000 35,000 35,000
77,500
55,500 25,000 310,000
Internal
35,000 34,000 12,500
2,200
0
1,500
7,800
2,300 0
95,300
Total 69,000
37,000
27,500 32,200 35,000 36,500
85,300
57,800 25,000 405,300
Profit/(loss) 21,500 24,500 (4,500)
2,300 10,000
7,500
3,500
35,000 (21,250) 78,550
Assets 12,250
77,800
25,000 24,000 40,000
7,730 145,000 55,000 4,300
391,080
Assuming that none are eligible for aggregation under the qualitative aggregation criteria set out at 3.2.1
above, which units are required to be reported as operating segments in the entity’s financial statements?
Applying the above quantitative thresholds, Units 1, 2, 5, 7, 8 and 9 should be identified as reportable
segments, as follows:
• A Unit whose internal and external revenue is 10% or more of the total revenue of all segments is a
reportable segment. On this criterion Unit 1 (17%), Unit 7 (21%) and Unit 8 (14%) are reportable segments.
• A Unit is a reportable segment if its profit or loss, in absolute terms, is 10% or more of the greater of the
combined profits of all profitable segments or the combined losses of all segments in loss. The combined
profit of all profitable segments is £104.3m, which is greater than the total of £25.75m for segments in
loss. On this basis, Unit 1 (21%), Unit 2 (23%), Unit 8 (34%) and the loss-making Unit 9 (20%) are
reportable segments.
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• A Unit is also a reportable segment if the measure of assets reported to the chief operating decision
maker is 10% or more of the total reported measure of assets of all segments. On this test, Unit 5 (10%)
joins the list of reportable segments, with Unit 2 (20%), Unit 7 (37%) and Unit 8 (14%) having been
already identified under other criteria.
In Example 32.7 above, units 1, 2, 5, 7, 8 and 9 are identified as reportable segments under
IFRS 8 by virtue of their size. No further aggregation of large segments such as these
would be possible unless all of the qualitative criteria set out at 3.2.1 above are met.
Even if an internally reported operating segment falls below all of the quantitative
thresholds, it may still be considered as reportable, and separately disclosed, if
management believes information about the segment would be useful to users of the
financial statements. [IFRS 8.13]. Where information about segment assets is not disclosed
under IFRS 8 because it is not provided regularly to the CODM, [IFRS 8.23], it would be
appropriate to ignore criterion (c) above for determining the reportable segments.
3.2.3
Combining small operating segments into a larger reportable
segment
Operating segments which individually fall below the size criteria may be combined
with other small operating segments into a single larger reporting segment provided that:
(a) the operating segments being combined have similar economic characteristics; and
(b) they share a majority (rather
than all) of the criteria listed at 3.2.1 above. [IFRS 8.14].
For the avoidance of doubt, if an entity proposes to combine a small operating segment
with one that exceeds any of the quantitative thresholds, they must share all of the
criteria described at 3.2.1 above. The requirement that combining segments must
demonstrate similar economic characteristics applies to combinations of both larger and
smaller operating segments into reportable segments, without exception.
3.2.4
‘All other segments’
At this stage the entity has been divided into a single set of components, based on the
elements reported to the chief operating decision maker. Components (operating
segments) have been combined where permitted by the Standard and the entity has
identified a number of individual operating segments or groups of operating segments
that are required to be disclosed separately in the financial statements because each
exceeds the quantitative thresholds for a reportable segment. The entity may then be
left with a number of operating segments which have not been identified as being
reportable, as well as other business activities that are not an operating segment or part
of an operating segment.
Information about other business activities and operating segments that are not
reportable should be combined and disclosed in a separate category for ‘all other
segments’. [IFRS 8.16]. However, this residual category cannot be too large. If total
external revenue for the operating segments already reported separately is less than 75%
of the entity’s revenue, the entity should identify additional operating segments for
external reporting until the 75% target is reached. In this situation segments would have
to be reported separately even if they fall below the quantitative thresholds described
at 3.2.2 above and are not otherwise regarded as being significant. [IFRS 8.15].
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There is no requirement to identify as a reportable segment the next largest internally
reported operating segment. The choice of additional reporting segments is aimed
simply to reach the 75% threshold, as illustrated below.
Example 32.8: Reaching the threshold of 75% of external revenue