In the fall of 2002, Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) issued memorandum of understanding called "The Norwalk Agreement", a commitment for developing a high quality standards that could be used for both domestic and cross-border financial reporting (FASB, 2006,1). Most of the major differences between the two Boards have already been resolved, such as Financial Accounting Standard (FAS) 154, Accounting changed and error corrections, FAS 153, Exchanges of productive assets, FAS 151, Inventory, International Financial Reporting Standards (IFRS) 5, Non-current Assets Held for Disposals and Discontinued Operations, and IAS 19, Employee Benefits. But the projects currently underway by FASB are Financial Performance Reporting by Business Entities, Revenue Recognition/Liability Extinguishment, Financial Instruments: Liabilities and Equity, and Research and Development. IASB projects underway are IAS 12, Income Taxes, IAS 14, Segment reporting, IAS 20, Government Grants, IAS 23, Borrowing Cost, IAS 33 Earnings per Share, and IAS 37, Provisions (IASPLUS, 2006,1). FASB has undertaken six initiatives to further the goal of convergence of United States Generally Accepted Accounting Principles (U.S. GAAP) with International Financial Reporting Standards (IFRS). Short term convergence project is one of the initiatives. Segment Reporting falls under Short term convergence project which has been in the agenda for almost four decades between the two standards. The differences of Segment Reporting is still an unresolved issue and the two boards are continuing to remove the differences so that convergence could be obtained, the exposure draft on this issue has been released as expected in the 4th quarter of 2005. But the question arises is that, are the differences in Segment Reporting material enough to delay the process?
Recent Board Meetings on Segment Reporting
a. January 2005 IASB Meeting
The Board considered reviewing the differences between IAS 14, Segment Reporting and SFAS 131, Disclosures about Segments of an Enterprise and Related Information. Before SFAS 131 was introduced the United States (US) standard was based on similar principles as laid down by IAS 14. But SFAS 131 was given more preference by the analyst because it provided more useful information reflecting the manner in which the entity manages the business. But one concern about SFAS 131 is that it does not require consistent accounting policies to be used between segment information and other financial reporting information. The SFAS 131 was also developed in conjunction with the Canadian standard setter and therefore it is already consistent with IFRS than most US pronouncements. The Board has agreed to make few changes to the updated pronouncement of SFAS 131.
b. March 2005 IASB Meeting
The staff recommended including non-public entities in the new proposed statement for segment reporting but it was denied because the issue of non-public entities would be considered when the boards deal with the Non-Publicly Accountable Entities (NPAE) project.
c. June 2005 IASB Meeting
The Board considered adding guidance similar to the standard issued by the Canadian Emerging Issues Committee. But this was also denied by the Board and no conclusion was made at this point.
d. November 2005 IASB Meeting
The Board agreed to use the term "Operating Segment" through out the exposure draft on amendments to IAS 14, Segment Reporting. Therefore the exposure draft would also be titled "Operating Segments."
e. January 2006 IASB Meeting
The Board issued the Exposure Draft ED 8 Operating Segments. The new proposed exposure draft adopts the "management approach" for reporting the financial performance of its operating segments (IASPLUS, 2006, 2).
Causes of Segment Reporting
The following major differences have caused the issue of Segment reporting to be put on the agenda of the boards, even prior 1980s. The main purpose of Segment reporting is to disclose the information about any entity's operations in different industries, its foreign operations and export sales, and its major customers. The need for Segment reporting occurred when the growth of complex companies with operations in different industries and geographic markets made the entity-level financial statements less useful to predict the future earnings and cash flows unless further detailed information was provided. It became a need for the investor to understand which of an entity's major operations were making the most positive contribution to the entity's results in order to make intelligent decisions. But on the other hand the preparers of the financial statements feared the disclosure of sensitive competitive data (Epstein and Mirza 2005, 628).
In the late 1960s the business organizations had become more complex and the evaluation of management's operating and financial strategies regarding different lines of businesses had become more difficult to evaluate. Therefore several national accounting rule making bodies began to address this topic. The need for Segment information was one of the first agenda items identified upon the FASBs formation in 1973 (Epstein and Mirza 2005, 628).
Role of SEC and the Accounting Setters
The United States, Securities and Exchange Commission, (SEC) were the first to make Segment Reporting disclosure. In 1970, SEC began requiring line-of-business information in registrant's annual filings. In 1974, SEC made it a requirement to include this data also in the annual reports issued to stockholders. In 1976, SFAS 14, Financial Reporting of Segments of Business Enterprise, was issued which established specific requirements for the disclosure of segment information. Later this requirement was declined for interim reports and for non-publicly-held companies. In August 1981, International Accounting Standards Committee (IASC) came out with IAS 14 with a similar model to the United States standard. In August 1997, IASC revised this standard by changing the method of determining reportable segments to include how a reporting entity is internally managed. In 1998, United States adopted the same approach of IAS 14 by revising SFAS 14 and establishing a new standard on Segment reporting as SFAS 131 (Epstein and Mirza 2005, 628).
IAS 14 and its effects
The first international standard on segment reporting, IAS 14 was applicable to both publicly held and all business organizations, other than those which were small, locally based, and non-diversified. Revised IAS 14, on the other hand was applicable to only those entities which had publicly traded equity or debt securities.
Reasons to Change SFAS 14
SFAS 14 had some major issues which required to be solved since it was creating inconvenience for the investors. One of the issues it had was, it did not provided any guidelines for the disclosure of the information regarding different segments. Tyson and Jacobs did a research on Segment reporting in the Banking Industry; they determined that the descriptive headings of Segment reporting were different including the position where it was disclosed. They found nine different headings used by 10 homogeneous companies within the same industry. The other problem with SFAS 14 was the proper definition of the segment. The 10 sample firms chose to group geographic regions but with different segments consisting of different regions. For example one company grouped as one segments all of its business operations in Asia, the Middle East and North Africa. The other company split the geographic region into two segments, Asia/Pacific and "other regions". With SFAS 14 there was lack of reliability, verifiability and neutrality (Jacobs and Tyson, 37). The lack of such primary characteristics of financial information according to the conceptual framework project, specifically SFAC No. 2 Qualitative Characteristics of Accounting Information (FASB 1980), occurred preparers discretion and the many ways disclosures presented by group of firms, resulting in lack of comparability and also understandability and decision usefulness . Also in June 1995, a research done by Wells, Thompson, and Phelps pointed out that practicing accountants perceived Segment reporting as having negative impact on entities in United States to compete internationally while the accounting educators, portfolio managers and chief financial officers perceived it as having a positive impact (Wells, Phelps, and Thompson, 35).
In September 1994, the American Accounting Association Financial Accounting Standards Committee responded to the FASB discussion memorandum "Reporting Disaggregated Information by Business Enterprises" mentioned that "the criteria set forth in SFAS No. 14 for identifying reportable segments are too vague and general. The notion of an "industry segment" lacks precision." The committee recommended defining segment reporting as "Operating Segment." The first time this was referred was in the position paper, "Financial Reporting in 1990s and beyond" by the Association for Investment Management and Research. The advantage for using "Operating Segment" approach was that the entities would organize themselves into operating sub-units to represent risk, growth factors and expected return. The entities would also manage the component operations in different ways depending on the economy and competition in the market which would identify the risk and return profile of each market segment. External data sources for the investors to analysis an industry risk and future return prospects such as Standard Industrial Classification (SIC) codes, which helps to compile the industry and trade statistics, also required the Committee to take actions towards the disclosure requirements of operating segments so that the data is compatible and enhance usefulness to assess current market conditions. The Committee also supported information of segmental data to be reported in interim basis (Barth, Bell, Collins, Crooch, Elliott, Frecka, Imoff, Landsman and Stephens, 76).
Exposure Draft on Segment Reporting
In January 1996, FASB and Accounting Standards Board of the Canadian Institute of Chartered Accountants issued an exposure draft, "Reporting Disaggregated Information about Business Enterprise" that changed the disclosures required by the US and Canadian Companies. This exposure draft was the first standard to be developed jointly with a standard setter body from another country. It was also the first standard to allow disclosures of accounting information that are not in conformity with Generally Accepted Accounting Principles (GAAP). But the authors Herrmann and Thomas pointed out again that the proposed statement did not increase the qualitative characteristics of accounting information as structured in SFAC No. 2. It decreased the representational faithfulness, materiality, neutrality and comparability qualitative characteristics of the disclosures (Herrmann and Thomas, 1996, 36).
American Accounting Association in its response to the IASC call for comment on its "Draft Statement of Principles on Reporting Financial Information by Segment" (March 1996). The Committee felt that the geographic data disclosure should be more desegregated, but only future research would determine if disclosing sales data is sufficient and that a broader set may be appropriate (Salter, Swanson, Achleitner, Lembre and Khanna 119). But the exposure draft was critiqued by Herman and Thomas (1997) pointing out that "it decreases the representational faithfulness of disaggregated information by maintaining a strict adherence to internal reporting practices even when this may result in inconsistent application between income statement and balance sheet" (Herrmann and Thomas, 1996, 40).
Emerge of SFAS 131
Almost 200 comment letters were received by the Board on the exposure draft. The FASB issued SFAS 131, Reporting Disaggregated Information about a Business Enterprise, in 1997. In September 2000, Herrmann and Thomas came out with another article on Segment disclosures in which they explained the differences between SFAS 14 and SFAS 131. SFAS 131 brought significant changes in the industry. Under SFAS, 14 it was required by firms to disclose segment information by both line-of-business and geographic area with no specific link to the internal organization of the company, resulting two sets of segment information, one used by the management internally and the other to report externally in conformance with SFAS 14. Under SFAS 131, majority of the firms define their operating segments by products and services, but some define it as geographic area or a combination of both. Also enterprise-wide disclosure regarding geographic areas, the proportion of country-level segment disclosure increased due to the adoption of SFAS 131, whereas the proportion of broader geographic area segment disclosures decreased (Herrmann and Thomas, 2000, 291).
Also in September 2000, Street, Nichols, and Gray came with a research paper on Segment disclosure and the improvements of SFAS 131 on Segment reporting. It proved that entities had more line-of-business segments under SFAS14; they are reporting more items of information about each segment due to the new standard, which has also improved consistency of the financial statements (Street, Nichols and Gray, 259). Also SFAS 131 improved monitoring and information strategies of the firms by increasing information desegregation revealing the firms to disclose previously hidden information about their diversification strategies which led to improvement in market valuation and monitoring of segment information by the firms (Berger and Hann, 163). The disclosure of hidden cross-segment transfers also lead to pricing correction and highlight managerial actions to ease cross-subsidization (Piotroski 2003, 233).
Major differences between IAS 14 and SFAS 131
Basis of Reportable Segment
Under IAS 14, it is necessary to define which business and geographical segments are reportable also whether the business segments or the geographical segments would be the primary mode of segment reporting, with alternative becoming the secondary mode, which is determined by the dominant source and nature of risk and return derived from the products or services or from operating in different countries or selling into different markets. For example, if an entity's strategic decisions are made in terms of geographical location of either operations or its customers then geographical segment will be the primary reporting format. If the decisions revolve around the product or service offerings, then business segment will be the primary format. On the other hand under US GAAP it is based on the operating segments and the way the management evaluates financial information for the purpose of allocating resources and assessing performance and it is reported internally to the top management, which may or may not be based on lines of business or geographical areas (Deloitte, 10). Following are some key differences:
Types of Segment Disclosures
Under IFRS, it requires disclosures for both "primary" and "secondary" segments. A substantial amount of disclosure is required for primary format then the secondary format. Under US GAAP, only one basis of segmentation is allowed, along with other certain "enterprise-wide" disclosure which requires showing revenues from major customers and revenues by country (Deloitte, 10).
Accounting Basis for reportable Segments
Under the IFRS standards, amounts are based on IFRS measurements. Whereas under US GAAP, amounts are based on whatever basis is used for internal reporting purposes and then these amounts are reconciled with the relevant amounts in the financial statements (Deloitte, 11).
Segment result
IFRS gives definition of Segment result which is Segment revenue minus segment expenses, before deducting minority interest. No such definition is available under US GAAP (Deloitte, 11).
These differences were resolved by the Boards by revising IAS 14. The IASB released the latest exposure draft on 19th January, 2006 Exposure Draft ED 8 "Operating Segment" , the comment period ends on May 19th 2006 and there has not been any announcement when the final standard will be proposed. But the proposed IFRS would apply to the annual financial statements for periods beginning on or after 1 January, 2007.
New Changes to ED 8
The new draft adopted the "management approach" to segment reporting which means the segment information is consistent with the management decisions which they use to make operating decisions, segment information will also be more consistent with the annual reports; the basic reason for this is to allow the investors and other financial statement users to better judge the company and this approach is also cost effective for the preparers as the same information would be used for internal and external reporting purposes (Herrmann and Thomas, 2000, 288). The new draft also adds to its scope the entities that hold assets in a fiduciary capacity for a broad group of outsiders. More level of reconciliation has been required for specified items and also to disclose geographical information about non-current assets excluding specified items and has required more segment information for interim financial reports. (IASB, 2006, 2)
Drawbacks of the ED 8
The proposed draft does not require disclosing the measurement of profit or loss for neither a segment nor it requires the measurement of profit and loss to be consistent with the attribution of assets to the reportable segments. Also additional disclosure is required by the new standard because segment reporting is a disclosure standard and therefore does not affect the reconciliation of IFRS amounts to US GAAP. (IASB, 2006, 1)
Conclusion
Continuing research reveals that segment reporting is one of the most important disclosures to users of financial statements. Radebaugh and Gray pointed out that U.S firms are faced with the most extensive segment reporting requirements in the world (Radebaugh and Gray, 1993). Surveys and interviews with representatives of various user groups conducted by the American Institute of Certified Public Accountants (AICPA): Special Committee on Financial Reporting, the Association for Investment Management and Research (AIMR): Financial Accounting Policy Committee, and the authors of the Construction Industry Computing Association (CICA) Research Study on Financial Reporting for Segments clearly indicated that users place a high value on Segment reporting (Barth, Bell, Collins, Crooch, Elliott, Frecka, Imoff, Landsman and Stephens 80). The differences between the two standards have been resolved up to a great extent in the new proposed exposure draft, but the accounting profession and the preparers of the financial statements would not prefer the idea of extended disclosures required by the new standard. Adoption of "Management Approach" would leak significant key analysis and decision making notions of the entity to the competitors and increase risk in the financial market for entities to compete. Also the increase in disclosure requirements for the segment information for the interim financial reporting would also not be welcomed by the prepares since it would create more work through out the year, but on the other hand the users of financial statements would benefit from this new standard; since more detail disclosure will be required by entities than it was in the past. Also proposed IFRS would be cost effective for the preparers because it will reduce the cost of providing disaggregated information for many entities, since it uses segment information that is generated for management's use, but again the issue remains that is the new proposed statement be more beneficial then the cost it would occur.
http://www.iasplus.com/standard/ifrs08.htm
http://www.iasplus.com/iasplus/0612ifrs8.pdf
http://www.accaglobal.com/members/publications/accounting_business/CPD/3026959
http://www.worldgaapinfo.com/pdf/IFRS/IFRS8.pdf
http://books.google.com/books?id=tvNJTW_lFe4C&pg=PA845&dq=IFRS+8+BC60&hl=en&ei=lB9CTL_4M4T58AaQmaHkDw&sa=X&oi=book_result&ct=result&resnum=2&ved=0CDkQ6AEwAQ#v=onepage&q=IFRS%208%20BC60&f=false
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