AS 17 likely to change with convergence

Dolphy D’Souza

The Institute of Chartered Accountants of India (ICAI) recently decided that Indian Accounting Standards will be fully in line with the IFRS (International Financial Reporting Standards) from April 1, 2011. The change from Indian GAAP (Generally Accepted Accounting Principles) to IFRS will have a significant impact on various entities’ financial statements and performance indicators.

The change will be felt not only in how the numbers are determined but also how they are disclosed.

One such instance is of segmentation rules which are likely to change in the near future in India as we converge with IFRS.

Under Indian GAAP, Accounting Standard-17 (AS-17), Segment Reporting, deals with disclosure relating to various operations of the business, so as to better understand the financial performance of the company and the underlying risks and rewards.

A business segment is defined as a distinguishable component of an enterprise that is engaged in providing an individual product, service or a group of related products/services and that is subject to risks and returns that are different from those of other business segments.

Enough emphasis was not given to how the CEO managed the business. This is soon going to change as we converge with IFRS. AS-17 is based on International Accounting Standarad-14 (IAS-14); however, IAS-14 is now replaced by IFRS 8 Operating Segments, and becomes effective for annual reporting periods beginning on or after January 1, 2009.

Under IFRS 8, an operating segment is defined as “a component of an entity:

That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity);

Whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and

For which discrete financial information is available.” As can be seen, unlike IAS 14, IFRS 8 whole heartedly adopts the management reporting approach to identifying operating segments.

As entities manage their businesses in different ways, segment reporting disclosures made by similar-sized entities in similar industries are unlikely to be directly comparable.

The International Accounting Standard Board (IASB) believes that financial reporting will improve because the management approach to the reporting of segments allows users of financial statements to examine an entity’s operations through the eyes of the management.

An important aspect of IFRS 8 is the requirement to disclose information that is actually being used internally by the management. The IASB believes that, because the segment information required to be disclosed will be readily available, it should help entities save time and money.

Overall, the IASB believes the benefits of the management approach, together with some expanded disclosure, will out-weigh the lack of comparability that might arise.

Under IFRS 8, for the purpose of identifying reportable segments, no distinction is made between revenues and expenses relating to transactions with third parties and revenues and expenses relating to transactions with other parts of the group. This means that vertically integrated operations may be composed of several segments for the purpose of IFRS 8.

However, under IAS 14 a business segment or geographical segment qualifies as a reportable segment only if a majority of its revenue is earned from sales to external customers. This is an important difference that may result in additional segments being disclosed under IFRS 8.

IFRS 8 requires that the amount of each segment item reported is the measure reported to the chief operating decision maker (CODM) in the internal management reports, even if this information is not prepared in accordance with IFRS accounting policies of the entity.

This may result in differences between the amounts reported in segment information and those reported in the entity’s primary financial statements. Contrast this with IAS 14, which requires the segment information to be prepared in conformity with the entity’s accounting policies for preparing its financial statements (that is, IFRS).

As IFRS 8 does not define segments as either business or geographical segments and does not require measurement of segment amounts based on an entity’s IFRS accounting policies, an entity must disclose an explanation of how it determined its reportable operating segments, and the basis on which the disclosed amounts have been measured and includes reconciliations.

A measure of profit or loss and assets for each segment must be disclosed. Additional line items, such as interest revenue and interest expense, are required to be disclosed if they are provided to the CODM. IAS 14, by contrast, specifies the items that must be disclosed for each reportable segment.

Under IFRS 8, disclosures are required when an entity receives more than 10 per cent of its revenue from a single customer.

Finally, it is appropriate to adopt the management approach to identify segments for segment reporting.

Whilst this is a positive step, the requirement to use management’s internal measures of segment results and assets, rather than the accounting policies used by the company in preparing its IFRS financial statements, is not appropriate.

However, this weakness has been mitigated in IFRS 8, by the requirement to provide reconciliation between segment results and assets as reported with the entity’s IFRS numbers in the financial statements.