Accounting Alert

This Accounting Alert is issued to provide an overview of Philippine Financial Reporting Standards (PFRS) 8, Operating Segments, to provide preparers and users of financial statements and those charged with governance of reporting entities some key implementation issues and interpretational guidance in certain problematic areas of PFRS 8.

Overview

High quality management accounts are essential to enable management to monitor how they are performing and how they need to allocate their resources.  This is particularly key for entities that operate in a variety of classes of business, geographical locations, regulatory or economic environments or markets. PFRS 8 aligns external reporting through the identification and reporting of operating segments with what is reported internally by management.

Definition of an Operating Segment

Operating segments are components of an entity with the following three characteristics:

• the component engages in business activities from which it may earn revenues and incur expenses,
• the component’s operating results are regularly reviewed by the Chief operating decision maker (CODM) to make decisions about resources to be allocated to the segment and assess its performance, and,
• discrete financial information is available for the component.

In addition, an operating segment may engage in business activities for which it has yet to earn revenues, for example, start-up operations may be operating segments before earning revenues. This approach focuses on how management has organized the entity to make key operating decisions and to assess performance.  Using the above criteria to identify operating segments may be straightforward for many entities. However, in less obvious situations each aspect of the definition needs careful consideration.

Practical issues in identifying operating segments

Before applying each characteristic, it is important to be clear who is the CODM.

Chief Operating Decision Maker (CODM)

PFRS 8 explains that the CODM is intended to mean a function rather than an executive with a specific title. The function is that of allocating resources to operating segments and assessing their performance.

• Segment managers - the relationship between the roles of CODM and segment managers needs to be reviewed carefully to identify when a segment manager is included within the function of CODM.  If the CODM is a group of individuals, including segment managers, the identification of operating segments is typically made at a lower level, resulting in the identification of additional operating segments.
• Review for changes to the identity of CODM - Once a CODM has been identified, it is important to reconsider if they still have the role following any business re-organizations,  acquisitions or disposals.  A change to the function that is undertaken by the CODM may also affect the identification of operating segments.

Components Engaged in Business Activities

The component merely needs to be capable of earning revenues or incurring expenses either currently or in the future.  Consequently, the following components of the business may be identified as operating segments if discrete financial information is available, and the operating results are regularly reviewed by the CODM.

• Pre-operating activities
• Corporate functions
• Components with outputs transferred exclusively to other segments
• Interests in joint operations and joint ventures
• Interests in associates
• Discontinued operations
• Post-employment benefit schemes

Operating Results Regularly Reviewed

An important criterion for identifying operating segments is the operating results are regularly reviewed by the entity’s CODM to make decisions about resources to be allocated to the segment and assess its performance. PFRS 8 does not define ‘regularly’ so judgment may be needed to decide if this condition is met. In practice, if the CODM reviews information on a quarterly or more frequent basis, this is expected to satisfy the condition.

• Data available at different levels
• Important information not reported to the CODM
• Press releases and other publicly available information
• Management commentary

Level of Discrete Information Available for CODM Review

The definition of an operating segment requires discrete financial information to be available to the CODM.  The level of detail needed by the CODM to assess performance and allocate resources to segments is considered to determine whether this condition is met.

• Only gross profit margin data is available
• Only revenue data is available
• Only cash flow data is available
• No segment statement of financial position data is available

Matrix organizations

The approach for identifying an operating segment in PFRS 8 focuses on how management has organized the entity to make key operating decisions and to assess performance.  Based on the above criteria, identifying operating segments may be obvious for many entities.  However, some entities produce multiple sets of reports detailing business activities in different ways, representing a matrix-management approach.  In a matrix form of organization, components of an entity may overlap with different aspects of components for which managers are responsible, with both being reported to the CODM.

Only one operating segment identified

One common issue identified in practice is where only one operating segment is identified.  Entities still need to apply the requirements of PFRS 8 if they only have one operating segment.

See attached Accounting Alert for further details.