Segment Reporting

Segment Reporting is the disclosure of public companies' financial details of key units or segments and is based on certain regulatory requirements. Such segment-wise reporting helps the company's stakeholders understand revenue, expenses, and other ratios for each business unit and decide on their investment accordingly.

This type of financial reporting aims at having the data segregated or segmented into different sections so that the report readers get a clear picture of the transactions that occurred for particular units in an organization. This analysis allows them to make wiser and more informed decisions.

Segment reporting of a company, as the name suggests, segments the finances recorded in the financial statements for any business. This way, the organizations divide their operational units into different categories and make the data available and accessible to stakeholders, including creditors and investors, who study for effective decision-making.

International Financial Reporting Standards (IFRS) sets guidelines to let businesses know how to report the information related to the segments in financial statements prepared annually. In the IFRS segment reporting process, large organizations divide their business into different units where these units are created based on their product or geographical location.

The units are termed as segments of the organization. At the end of the year, all units are to be merged with that of the organization, but certain units, as per the criteria mentioned, have to be reported separately.

The objectives of segment reporting are described as under -

• For a better understanding of the performance and evaluation of the organization's results.
• To provide the information to the stakeholders about the important units of the organization to evaluate and make decisions about the investment.
• To make the accounts more transparent and understandable.
• To make better decisions by taking in mind the business from different segments.
• For a better analysis of the risk and returns of the organization.
• To analyze the most profitable or Loss-making units.

When it comes to segment reporting, it is important for businesses or individuals to understand what makes an operating unit eligible to be presented as a segment. Hence, there are some of the segment reporting criteria that one must be aware of to understand which unit to present as segment and why so.

Let us have a look at some of those qualifying factors below:

• Revenue of segment is to be greater than or equal to 10 percent of the revenue of the organization as a whole; or
• Profit of the segment is to be greater than or equal to 10 percent of the profit of the organization; or
• The segment's assets are to be greater than or equal to 10 percent of the organization's total assets.

Suppose any segment meets any of the above criteria. In that case, that segment is to be reported separately, i.e., all income, expenses, assets, and liabilities of that segment are shown separately as per the requirements of law.

Let us consider the following instances to understand the segment reporting definition better:

Example 1

Suppose Company A Ltd has eight units based product-wise. Each unit deals with different products. The Revenue, Profits, and the Assets of each unit are shown as under –

(Amount in $ in Million)

Which units are to be reported as per segmental reporting?

Solution

The unit is to be reported as per segment reporting if -

• Assets of the unit are greater than or equal to 10 percent of the organization's total assets.
• Profit or loss is more than or equal to 10 percent of the organization's total profit or loss.
• Revenue is more than or equal to 10 percent of the total revenue of the organization.

Accordingly, the calculation of each unit given above for segmental reporting is under –

Units A, B, D, E, F, and G are to be reported as segments as per segmental reporting, and units C and H are not to be reported separately as the total revenue or assets, or profit is less than 10% of the total of that area of the organizations as a whole.

Example 2

The Financial Accounting Standards Board (FASB) announced modifications in the segment reporting requirement in July 2023. As per the latest update that the rule-making authority shared, the businesses that are public will have to share even minute details of their giant transactions in the segment reports.

While earlier the businesses segmented their operations unit on the basis of geography or business line, they would require breaking down the transaction details of big-ticket expenses into minute segments for a better and clearer picture of business’ performance.

Segmental reporting is important for the organization, its investors, and the stakeholders in the following way:

• It provides investors the complete details about the units, their profitability, etc. They can analyze and decide upon the investment in the organization.
• It helps the organization in better decision making as the planning about expansion or diversification is to be done based on the result of the segment.
• It helps the creditors decide the credit terms based upon the analysis of each segment separately.
• It helps the shareholders decide whether to retain the shares or sell them.
• It helps management decide whether to expand the segment or sell off the segment.

With segment reporting, the expenses and revenues are grouped into distinct categories. As a result, the ones who read it can interpret it in a better way. Investors and other stakeholders, including creditors get a chance to get a deeper look into the details and thereby make well-informed decisions. There are many other advantages that this type of reporting offers. Let us have a look at them below:

• Segmental Reporting gives a better understanding of financial statements.
• The profit-making and loss-making units can be easily identified with the help of segmental reporting.
• It helps in the optimum utilization of resources and better presentation.
• It helps potential investors in better investment decisions.

Besides the merits of this reporting of financial statements, there are flaws that one must also explore. Following are some of the limitations of segment reporting:

• There are many disclosures required in the case of segmental reporting; hence it is a time-consuming process.
• The data presented can be misinterpreted by the investors or creditors.
• Method of reporting Inter-segment transactions are different for each organization.
• The base of the segment is also different as some organizations divide the segment based on geographical location, and some organizations divide it based on product-wise.
• The common costs are sometimes difficult to allocate.

This has been a guide to what is Segment Reporting. Here, we explain its examples, requirements, objectives, advantages, importance, and disadvantages. You may learn more about financing from the following articles –

• Segment Margin
• Product Diversification
• Reporting Period
• Financial Reporting