Both U.S. GAAP and IFRS require firms to report certain information about each of their operating segments. What segment information and disclosures are required?

Answer 1

ANALYSIS OF SEGMENT DATA

Both U.S. GAAP and IFRS require firms to report certain information about each of their operating segments. These disclosures permit analysis of profitability at an additional level of depth.

Required Segment Information

Authoritative guidance requires firms to disclose information on their operating segments. The definition of segments takes a management approach. Specifically, U.S. GAAP and IFRS define an operating segment as a unit within a firm for which management prepares separate financial information and which management regularly evaluates in allocating resources and assessing performance. By defining segments in the same way that management operates a business, accounting guidance aims to provide users of the financial reports with the same sort of information that management uses to evaluate business components. Although firms have flexibility in defining their operating segments, this flexibility results from choices management makes to organize and manage the entity. For example, a firm that chooses to organize, manage, and evaluate its business along geographic lines would define its operating segments along geographic lines. As a practical matter, most firms report segment information by products and services, indicating that most firms appear to be organized on these same lines. Firms might also report information by geographical markets (if information is available without undue cost) and by customers who represent more than 10% of revenues (called major customers).

Both U.S. GAAP and IFRS provide quantitative criteria for determining how many segments a firm should report. Firms must report segment information for any operating segments that constitute 10% or more of revenues, assets, or profit and loss; and they must report enough segment information to account for at least 75% of the entity's total revenues. For each operating segment, firms must report information about revenues, assets, and measures of the segment's operating results, as well as components of operating profit or loss, including depreciation, interest revenue, and interest expense. Firms also generally report information about long-lived assets and capital expenditures. IFRS, but not U.S. GAAP, also requires disclosure of segment liabilities, if management uses this information as part of the normal reporting structure to manage and evaluate the business.

Firms must reconcile data for their operating segments with total revenues, operating income, and assets at a firm-wide level. Segment revenues usually sum to firm-wide revenues. Segment operating income will not equal firm-wide operating income because firms do not allocate all corporate-level expenses (for example, compensation of top management and interest expense) to operating segments. Segment assets will not equal firm-wide assets because firms do not allocate corporate-level assets (for example, corporate headquarters) to operating segments.

We can compute ROA, profit margin for ROA, and total assets turnover for each segment using the segment disclosures. The amounts for these ratios computed at a segment level differ from those at a corporate level for at least two reasons:

1 . The numerator of ROA at a firm-wide level includes all revenues and expenses except interest expense net of taxes, whereas the numerator of ROA using the segment data includes operating revenues and expenses only. Segment operating income excludes interest revenue and income taxes, which the firm-wide ROA includes.

2 . The denominator of ROA at a firm-wide level is the average of assets at the beginning and end of the year, whereas we use total assets at the end of the year in computing segment ROAs. Although we could use average assets to compute segment ROAs, doing so would require four years of segment asset data. Firms often change the definition of their segments, making it difficult to obtain four years of comparable data for segment assets.