Operating segments: the questions regulators keep asking

Short answer: Segment notes are challenged on the same handful of points every time: who the chief operating decision maker is, why the number of segments does not match the way the company describes itself elsewhere, what justifies each aggregation, and whether the reconciliations to the financial statements actually tie. All four are answerable in advance, and all four are about evidence.

Why this note gets picked on

Ind AS 108 is a management-approach standard. It does not tell you what your segments are; it tells you to report what your chief operating decision maker reviews. That makes the note unusually easy to challenge, because the challenger can compare it against everything else the company says about itself: the annual report’s business review, the investor presentation, the earnings call, the website, the board papers. When those describe four businesses and the note shows one, the question asks itself.

I am not quoting any regulator or citing any enforcement decision here. These are the questions that recur when a segment note is examined, whether the examiner is an auditor, an audit committee or a reviewer.

Question one: who is the CODM, and where is the proof?

The chief operating decision maker is identified by function. It is whoever allocates resources to the operating segments and assesses their performance. It may be the managing director, a management committee, or the board.

What gets asked for is the evidence: the pack that function actually receives, at the frequency it receives it. If the pack has a revenue and margin page per business line, the segment note that shows one line is inconsistent with the pack, and the pack wins. Groups that get this right keep a short memo naming the CODM, listing the reports it receives, and cross-referring to the board minute that shows them being reviewed.

Question two: why these segments, and why this many?

An operating segment is a component that engages in business activities from which it earns revenues and incurs expenses, whose results are regularly reviewed by the CODM, and for which discrete financial information is available. All three conditions.

From there, reportable segments are determined by the quantitative thresholds. A segment is reportable if its revenue is 10% or more of combined revenue, or its reported profit or loss is 10% or more of the greater of the combined profit of all profitable segments and the combined loss of all loss-making segments, or its assets are 10% or more of combined assets. If the reportable segments together account for less than 75% of external revenue, you add segments until they do, even if those additions are individually below the thresholds. The standard also suggests considering a practical limit when the number of reportable segments goes beyond about ten.

The common defect is not too few segments. It is a segment structure that has not changed in six years while the business has.

Question three: what justifies the aggregation?

Two or more operating segments may be combined only if aggregation is consistent with the core principle of the standard, the segments have similar economic characteristics, and they are similar in each of the relevant respects: the nature of the products and services, the nature of the production processes, the type or class of customer, the methods used to distribute, and, where applicable, the nature of the regulatory environment.

“Similar economic characteristics” is where the argument happens. Two businesses with gross margins of 8% and 34% are not similar because they are both sold to industrial buyers. If you aggregate, write down the test you applied, with the numbers you tested, before the audit rather than during it.

Question four: do the reconciliations tie?

Segment amounts are reported on the basis given to the CODM, which may not be an Ind AS measure at all. That is allowed, and it is why the reconciliations matter. Segment revenue, segment profit or loss, segment assets and segment liabilities each reconcile to the corresponding amount in the financial statements, with material reconciling items identified separately.

What is asked here is arithmetic, and it is where a note most often fails on its own terms: an “unallocated” or “others” reconciling column large enough to be a segment in its own right, or a total that is short by an amount nobody can name. Also check the basis of measurement is described: how inter-segment transactions are priced, how shared costs are allocated, and what the segment measure includes and excludes.

The disclosures people forget

• Entity-wide disclosures apply even to a single-segment entity. Revenue from external customers by product and service, revenue and non-current assets split between the country of domicile and material foreign countries, and major customer concentration.
• A material foreign country is disclosed separately. “India and outside India” is not enough when one overseas country is material on its own.
• Segment liabilities are disclosed only if reviewed by the CODM. So are segment assets. Disclosing them when they are not reviewed is as much a misstatement of the management approach as omitting them when they are.
• Changes in segment structure require restated comparatives, with an explanation, unless the information is not available and the cost to develop it would be excessive.
• Interim reporting carries segment disclosures too, so the structure has to be settled before the first quarter, not at year end.

What I would do before the next year end

1. Write the CODM memo, naming the function and listing the reports it receives.
2. Line up the segment note against the investor presentation and the business review, side by side, and explain every difference.
3. Re-run the quantitative thresholds on current-year numbers rather than assuming last year’s structure still passes.
4. Document each aggregation with the economic characteristics you tested.
5. Tie every reconciliation to the rupee, and name any reconciling item over a set threshold.
6. Check the entity-wide disclosures separately, because they are the ones prepared last.

Where FINAHQ fits

Segments hold up when they are defined once against the mapped data and reported from it, rather than maintained in a workbook beside the statements. FINAHQ does segment reporting from the same mapped entries as the statements, so the reconciliation to reported revenue, profit and assets is a computation rather than a negotiation. The management-reporting side of the same problem is in segment reporting and management MIS from the same numbers. To see what it does to your close, calculate your value or talk to us.

This article is general information, not professional advice. Check the current text of Ind AS 108 and discuss your position with your auditors.