Segment Reporting, as prescribed under Accounting Standard 17 (AS 17), plays an important role in improving the transparency and usefulness of financial statements. The main objective of this standard is to ensure that stakeholders are provided with meaningful information about the different lines of business and geographical areas in which an enterprise operates. Such disclosures allow users to better understand the performance of an enterprise, evaluate the risks and returns associated with different parts of the business, and make more informed decisions about the organisation as a whole.
Many enterprises today operate across multiple product lines and in diverse geographical regions. These operations are often subject to variations in profitability, growth prospects, competition, and risk factors. Consolidated financial statements alone may not reveal the performance of different divisions or business units, making it difficult for users to judge the strengths and weaknesses of an enterprise. Segment reporting bridges this gap by presenting disaggregated financial information.
Objective and Scope of AS 17
The central objective of AS 17 is to establish principles for reporting financial information about different types of products, services, and geographical areas in which an enterprise conducts its business. The scope of the standard extends to both primary and secondary segments. While primary segments are based on the dominant source of risk and return (either business or geographical), secondary segments provide supplementary information.
The scope of this standard is applicable to enterprises whose equity or debt securities are listed on a recognised stock exchange, as well as to other large enterprises that meet prescribed thresholds for turnover, borrowings, or employee strength. Smaller enterprises, however, are exempt from segment reporting requirements.
Importance of Segment Reporting
Segment reporting serves several key purposes that make it highly valuable for stakeholders.
Better Understanding of Enterprise Performance
Disclosures about segments give investors, analysts, and other users of financial statements a more detailed picture of how the business is performing across its different activities. For example, an enterprise that manufactures both consumer goods and industrial equipment may experience high profitability in one segment and losses in another. Consolidated figures could mask these variations, whereas segment reporting highlights them.
Assessment of Risks and Returns
Different business segments or geographical areas may carry differing risks. For instance, a company operating in both domestic and international markets faces risks related to foreign exchange fluctuations, regulatory frameworks, and economic conditions abroad. Segment reporting helps assess how these risks and returns are distributed across the enterprise.
Informed Decision-Making
By providing information about profitability, asset utilisation, and capital expenditure in different segments, AS 17 helps stakeholders make judgements about the sustainability and growth potential of each segment. It also allows investors to compare the performance of similar segments across different companies in the same industry.
Principles of Segment Identification
An enterprise must first determine its reportable segments before making disclosures. Segments are generally classified as either business segments or geographical segments.
Business Segments
A business segment is a distinguishable component of an enterprise that provides a product or service, or a group of related products or services, subject to risks and returns that are different from those of other business segments. Indicators for identifying business segments include the nature of products or services, production processes, distribution methods, and regulatory environment.
Geographical Segments
A geographical segment is a distinguishable component of an enterprise that operates within a particular economic environment and is subject to risks and returns different from those of other regions. Factors considered in identifying geographical segments include the similarity of economic and political conditions, relationships between operations in different geographical areas, proximity of operations, and risks related to currency and exchange controls.
Disclosure Requirements under AS 17
Once reportable segments are identified, enterprises must disclose certain information for each segment. The disclosures are designed to provide transparency and comparability.
Segment Revenue
The first major disclosure requirement is segment revenue, which should be classified into:
- Sales to external customers: These represent revenues earned directly from customers outside the enterprise.
- Inter-segment transactions: These are sales or transfers between different segments of the enterprise, which must be disclosed separately to show the true performance of each segment.
This classification ensures that revenue from internal transfers does not inflate the figures and provides clarity about external versus intra-enterprise business.
Segment Result
Each segment must report its segment result, which represents profit or loss before interest and tax, after deducting directly attributable expenses and allocating relevant common costs. This disclosure highlights the profitability of each segment and provides insights into which areas of the business are performing well.
Segment Assets
Enterprises must disclose the total carrying amount of assets belonging to each segment. Segment assets are those that are employed in the operating activities of the segment and are either directly attributable or can be reasonably allocated to the segment. This information is essential for assessing how resources are distributed across segments.
Segment Liabilities
Similar to assets, enterprises must disclose the total liabilities of each reportable segment. These include obligations that are directly attributable to a segment or can be allocated on a reasonable basis. Segment liabilities help users understand the risk profile of each segment and the extent of financial exposure.
Capital Expenditure on Segment Assets
Another important disclosure is the total cost incurred during the reporting period to acquire assets that are expected to be used for more than one accounting period. These are categorised into:
- Tangible fixed assets: such as property, plant, and equipment.
- Intangible fixed assets: such as patents, trademarks, and software.
This disclosure provides information about investments made in expanding or maintaining the operational capacity of each segment.
Depreciation and Amortisation
The total amount of depreciation and amortisation expense on segment assets must be disclosed for each segment. This figure is important for understanding the wear and tear on assets and the impact on segment results.
Non-Cash Expenses
Enterprises must disclose significant non-cash expenses other than depreciation and amortisation that are included in the segment expense and deducted in measuring the segment result. Examples include provisions for doubtful debts, write-downs of inventory, or impairment losses. These disclosures provide clarity on how much of the segment result is affected by non-cash charges.
Significance of Disclosure Requirements
The disclosure requirements under AS 17 ensure that segment information is presented in a structured and consistent manner. Each item disclosed provides unique insights:
- Segment revenue allows differentiation between internal and external sources of income.
- Segment results demonstrate the profitability of individual business units.
- Segment assets and liabilities show resource allocation and financial obligations.
- Capital expenditure highlights long-term investments.
- Depreciation, amortisation, and non-cash expenses indicate the quality and sustainability of earnings.
By complying with these requirements, enterprises enhance the credibility of their financial statements and enable stakeholders to form well-rounded views of the enterprise’s operations.
Application of AS 17 in Practice
While the theoretical framework of AS 17 outlines clear disclosure requirements, its application in practice requires enterprises to adopt systematic approaches for identifying reportable segments, attributing revenues and expenses, and presenting the information in financial statements. The practical challenges and nuances in implementation are important to understand for both preparers and users of financial statements.
Identification of Reportable Segments
An enterprise must first establish its reportable segments. This step is crucial because only those segments which meet certain quantitative thresholds need to be separately disclosed, while others may be grouped under unallocated or miscellaneous categories.
Quantitative Thresholds
AS 17 prescribes that a business or geographical segment should be identified as a reportable segment if it meets any of the following conditions:
- Its revenue, including sales to external customers and inter-segment sales or transfers, is 10 percent or more of the total revenue of all segments.
- The segment result, whether profit or loss, is 10 percent or more of the combined result of all segments in profit or all segments in loss, whichever is greater in absolute terms.
- The segment assets are 10 percent or more of the total assets of all segments.
These thresholds ensure that only segments of material significance are reported, thereby reducing clutter and ensuring that users receive relevant information.
Aggregation of Segments
In some cases, two or more segments may be combined and reported as a single segment if they exhibit similar economic characteristics and are subject to similar risks and returns. However, the aggregation must not compromise transparency, and enterprises must provide adequate explanation of the basis for such aggregation.
Measurement Principles
Once reportable segments are identified, the next step is the measurement of revenue, results, assets, and liabilities.
Segment Revenue Measurement
Segment revenue includes both sales to external customers and inter-segment transactions. However, inter-segment transactions are recorded at prices charged between segments, which may or may not reflect market prices. Enterprises must apply consistent methods of pricing for internal transfers to ensure comparability.
Segment Expense Measurement
Expenses directly attributable to a segment are charged to that segment. Common expenses, which are incurred for the benefit of more than one segment, are allocated on a reasonable basis. For instance, administrative overheads may be allocated on the basis of revenue, headcount, or usage of facilities. Unallocated expenses that cannot be reasonably assigned are shown separately.
Segment Asset Measurement
Segment assets include operating assets employed in the activities of the segment that are directly attributable or can be reasonably allocated. These include property, plant, equipment, receivables, and inventory. Assets that are jointly used by multiple segments, such as central head office buildings, are treated as unallocated.
Segment Liability Measurement
Segment liabilities include those obligations that arise from operating activities of the segment. These may be directly attributable or reasonably allocated. Liabilities such as borrowings used for central treasury operations are often shown as unallocated.
Primary and Secondary Segment Reporting
AS 17 requires enterprises to identify either business segments or geographical segments as the primary segment format, depending on which reflects the dominant source of risk and return. The other format is then treated as secondary.
Business Segments as Primary
If an enterprise is predominantly diversified in terms of products and services, business segments are treated as the primary reporting format. For instance, a company operating in sectors such as chemicals, pharmaceuticals, and consumer goods may present its segment disclosures primarily by business lines.
Geographical Segments as Primary
If the risks and returns of an enterprise are primarily influenced by geographical factors, geographical segments become the primary reporting format. For example, an enterprise with operations in Asia, Europe, and North America may report geographical segments as primary, especially if political, economic, and currency conditions vary significantly between regions.
Secondary Segments
Secondary segment reporting provides additional information. For example, if business segments are primary, geographical segments are reported secondarily. The disclosures for secondary segments are less detailed but still provide useful insights.
Illustrative Disclosures
To appreciate the disclosures required under AS 17, consider a hypothetical company engaged in manufacturing and exporting two types of products across domestic and international markets.
Segment Revenue Example
- Consumer goods: Revenue from domestic customers and exports, as well as inter-segment transfers.
- Industrial goods: Similar classification into external sales and transfers to other segments.
This separation allows stakeholders to evaluate how much of the total revenue is derived from external markets and how much from internal transfers.
Segment Result Example
The profit or loss for each segment is calculated by deducting segment-specific expenses and allocated overheads. If consumer goods generate high profits while industrial goods incur losses, the segment reporting highlights this contrast clearly.
Segment Assets Example
Consumer goods may have assets such as machinery, factories, and receivables located domestically, whereas industrial goods may have substantial assets located abroad. Reporting these separately allows stakeholders to understand the resource base of each segment.
Challenges in Implementation
While the disclosure requirements are comprehensive, enterprises often face challenges in implementing AS 17 effectively.
Allocation of Common Costs
One of the major difficulties lies in allocating common costs fairly among segments. Head office expenses, research and development costs, or central administrative charges may not have a clear link to any single segment. The allocation must be based on reasonable criteria, but this introduces subjectivity.
Transfer Pricing Between Segments
Another challenge arises in determining the pricing of inter-segment transfers. If prices are set arbitrarily, they may distort segment results. While market-based pricing is preferred, it may not always be practical.
Handling Unallocated Items
Certain assets, liabilities, and expenses cannot be reasonably assigned to any segment, such as central treasury borrowings or investments in joint ventures. Enterprises must present these as unallocated items, but excessive reliance on this category may reduce the usefulness of segment information.
Comparability Across Enterprises
Although AS 17 prescribes broad principles, variations in allocation methods, pricing policies, and definitions of segments can reduce comparability between enterprises. Analysts must therefore exercise caution when making cross-company comparisons.
Benefits of Segment Reporting for Stakeholders
Despite challenges, the benefits of segment reporting are substantial.
For Investors
Investors gain insights into which segments are generating profits and which are underperforming. This helps them assess the sustainability of earnings and identify growth opportunities.
For Management
Segment information serves as an internal performance measurement tool. It helps management evaluate the efficiency of different divisions, allocate resources, and design strategies tailored to specific markets or products.
For Regulators
Regulators and standard-setting bodies use segment information to assess whether enterprises are providing transparent disclosures. This helps in maintaining investor confidence in financial markets.
For Lenders and Creditors
Lenders are interested in knowing the risks and returns associated with different parts of the business. Segment reporting allows them to evaluate whether cash flows from specific segments are sufficient to service debt obligations.
Comparative Analysis with Global Standards
AS 17 shares similarities with International Accounting Standard 14 (IAS 14), which was its inspiration. However, global standards have since evolved with the adoption of IFRS 8 Operating Segments.
Key Differences with IAS 14
- IAS 14 also prescribed business and geographical segments but placed greater emphasis on risks and returns.
- AS 17 is closely aligned with IAS 14 in terms of structure and requirements.
Transition to IFRS 8
Internationally, IFRS 8 replaced IAS 14. IFRS 8 adopts a management approach, requiring enterprises to disclose information based on internal reports reviewed by management. AS 17 continues to follow the earlier approach, but convergence efforts in India through Ind AS 108 have aligned reporting with IFRS 8.
Practical Considerations for Enterprises
Enterprises adopting AS 17 must consider several practical issues to ensure compliance and usefulness of disclosures.
Consistency in Reporting
Methods of allocating costs, recognising revenue, and valuing assets must be applied consistently from period to period. Inconsistencies reduce comparability and may mislead users.
Materiality of Segments
Not all segments need to be reported separately. Enterprises must exercise judgement in determining materiality, while ensuring that users are not deprived of significant information.
Clear Presentation
Segment information must be presented in a manner that is clear and easy to understand. Tabular formats with accompanying notes are generally preferred. Overly complex disclosures may defeat the purpose of transparency.
Future Developments in Segment Reporting
While AS 17 remains applicable, accounting standards continue to evolve. In India, convergence with International Financial Reporting Standards has led to the adoption of Ind AS 108, which follows the management approach of IFRS 8. However, AS 17 still applies to enterprises not covered by Ind AS.
The trend in global reporting is towards greater reliance on internal management perspectives, which may provide more relevant information but also requires robust internal reporting systems.
Advanced Perspectives on Segment Reporting under AS 17
Segment reporting is not only a compliance exercise but also a strategic tool that offers insights into the operations of an enterprise. As businesses diversify and expand globally, the importance of transparent and reliable segment disclosures becomes more pronounced. We explore advanced perspectives, extended examples, interpretative challenges, and analytical applications of AS 17.
Analytical Use of Segment Information
Segment data disclosed in compliance with AS 17 can be analysed by various stakeholders to gain deeper insights into an enterprise’s performance and prospects.
Profitability Analysis
Segment profitability allows analysts to distinguish between high-performing and underperforming business divisions. For instance, if one product line consistently generates strong margins while another lags behind, investors may demand restructuring or divestment. Segment information thus highlights profit concentration areas.
Risk Profiling
By assessing segment assets and liabilities, stakeholders can identify which segments carry higher financial risks. A segment heavily funded by borrowings may pose a liquidity risk, whereas a segment with significant receivables may be exposed to credit risk. Geographical disclosures further help in evaluating risks associated with political instability or currency fluctuations.
Growth Opportunities
Capital expenditure disclosures in segment reporting point towards future growth prospects. If an enterprise consistently invests in a particular segment, it signals management’s strategy to expand operations in that area. Stakeholders can align their expectations with these growth initiatives.
Illustrative Case Example
Consider a diversified enterprise engaged in three primary business segments: consumer goods, healthcare products, and industrial machinery. Additionally, the enterprise operates across domestic and overseas markets.
Segment Revenue
- Consumer goods generate substantial domestic sales and moderate international sales.
- Healthcare products rely primarily on export markets due to higher demand overseas.
- Industrial machinery focuses on domestic contracts, with inter-segment transfers supplying parts to the healthcare segment.
This level of disclosure allows stakeholders to see the relative contribution of external customers and internal transfers.
Segment Results
- Consumer goods show steady profits, reflecting stable domestic demand.
- Healthcare products, while volatile, contribute higher margins due to strong export prices.
- Industrial machinery faces losses due to heavy competition and rising input costs.
By presenting these results separately, stakeholders can appreciate that overall profitability is driven by healthcare exports, even though industrial machinery drags down consolidated results.
Segment Assets and Liabilities
- Consumer goods hold significant manufacturing facilities domestically.
- Healthcare products maintain overseas research centres and distribution networks.
- Industrial machinery has large fixed assets tied up in underutilised plants.
The segment liabilities also reveal that the industrial machinery division is financed through debt, creating potential solvency concerns.
Common Interpretative Issues
While AS 17 prescribes clear disclosure requirements, interpretation may vary across enterprises, giving rise to several issues.
Treatment of Shared Assets
Central assets, such as head office buildings or IT infrastructure, may support multiple segments. The question arises whether such assets should be allocated to segments or kept unallocated. AS 17 allows reasonable allocation, but subjectivity often remains.
Determination of Transfer Prices
Inter-segment transfers are another area of debate. If transfer prices are set artificially low or high, segment results can be distorted. Market-based pricing provides neutrality but may not always be feasible, particularly when unique goods are transferred.
Allocation of Overheads
Overheads such as advertising, human resources, or legal expenses benefit multiple segments. The allocation basis may differ among enterprises, making comparability difficult. Some allocate based on revenue, others on headcount, or usage. This subjectivity affects reported results.
Currency Translation for Geographical Segments
When geographical segments are reported, translation of foreign operations into domestic currency introduces additional complexity. Exchange rate fluctuations may inflate or deflate segment results and assets, making it difficult to assess operational performance independently of currency movements.
Sector-Specific Applications
Segment reporting takes on unique relevance in different industries due to their business models.
Manufacturing Industry
In manufacturing, segment reporting highlights product line performance. For example, an automobile company may disclose results separately for passenger cars, commercial vehicles, and spare parts. This helps in identifying which vehicle category drives profitability.
Information Technology
In IT services, geographical segments are particularly relevant. A company may disclose revenues from North America, Europe, and Asia separately. Investors assess dependency on a single region and exposure to global demand fluctuations.
Banking and Financial Services
Although banks are not generally required to follow AS 17 in the same way as industrial companies, segment disclosures about retail banking, corporate banking, and investment services provide clarity on risk distribution. Regulators and investors pay attention to such information.
Pharmaceuticals
For pharmaceutical companies, business segments may include generics, branded drugs, and research and development. Each has distinct risk-return profiles, and disclosures provide transparency about profitability and investment in innovation.
Role of Segment Reporting in Corporate Strategy
Segment information not only assists external stakeholders but also plays a crucial role in shaping corporate strategy.
Resource Allocation
Management relies on segment data to allocate resources effectively. Profitable segments may be prioritised for capital expenditure, while underperforming segments may be candidates for restructuring.
Performance Evaluation
Divisional managers are often assessed based on segment results. Segment reporting thus serves as a basis for internal accountability and performance-linked incentives.
Strategic Decisions
Whether to enter new markets, expand existing product lines, or exit loss-making divisions often depends on the trends revealed by segment disclosures. The detailed insights from AS 17 provide a factual foundation for such decisions.
Evolution from AS 17 to Ind AS 108
In India, while AS 17 continues to apply to certain enterprises, larger companies governed by Indian Accounting Standards (Ind AS) follow Ind AS 108 Operating Segments. Understanding the differences provides context for the evolving nature of segment reporting.
Management Approach of Ind AS 108
Unlike AS 17, which prescribes disclosure based on risks and returns, Ind AS 108 adopts the management approach. This means segments are identified based on internal reports reviewed by the chief operating decision-maker. The disclosures therefore reflect management’s perspective, aligning external reporting with internal decision-making.
Comparative Impact
Under AS 17, segment reporting is relatively rigid, requiring disclosure based on business or geographical segmentation. Under Ind AS 108, flexibility is greater, but consistency between internal and external reporting becomes essential. For enterprises still applying AS 17, understanding this evolution highlights potential future shifts.
Impact on Financial Analysis
Segment disclosures provide analysts with valuable inputs beyond consolidated statements.
Ratio Analysis
By examining segment-level margins, return on assets, and debt-equity ratios, analysts can assess the efficiency of each segment. Comparisons across segments within the same enterprise reveal areas of strength and weakness.
Trend Analysis
Tracking segment revenue, results, and capital expenditure over time provides trends that are often masked at the consolidated level. Stakeholders can identify whether a segment is consistently improving or declining.
Peer Comparison
Analysts can compare the segment disclosures of one enterprise with its competitors. For example, two consumer goods companies may operate in similar product categories, but their segment profitability could differ due to cost structures or market presence.
Limitations of Segment Reporting
Despite its usefulness, segment reporting under AS 17 has limitations.
Subjectivity in Allocation
As noted, allocation of common costs, transfer pricing, and treatment of unallocated assets introduces subjectivity, reducing comparability.
Potential for Manipulation
Management has discretion in defining segments and allocating expenses. This creates opportunities to shift profits or losses between segments, a practice sometimes referred to as segment smoothing.
Data Overload
While disclosures are meant to enhance transparency, excessive detail may overwhelm users. Striking a balance between relevance and simplicity remains a challenge.
Practical Illustrations
To demonstrate application, consider a hypothetical disclosure table:
- Segment A: Revenue 500, Profit 120, Assets 800, Liabilities 300, Capital Expenditure 100
- Segment B: Revenue 300, Profit 50, Assets 500, Liabilities 200, Capital Expenditure 80
- Segment C: Revenue 200, Loss 30, Assets 400, Liabilities 250, Capital Expenditure 60
This simplified illustration shows how stakeholders can immediately spot that Segment A drives most profitability, Segment C incurs losses, and resource allocation is uneven.
Future Outlook for Segment Reporting
The increasing demand for transparency, global convergence of accounting standards, and the integration of non-financial information into reporting indicate that segment disclosures will continue to evolve. Enterprises may be expected to provide not only financial but also operational and sustainability-related information by segments in the future.
Conclusion
Segment reporting under AS 17 plays a critical role in enhancing the transparency and usefulness of financial statements. By requiring enterprises to disclose detailed information about their different business and geographical segments, the standard helps users of financial statements gain a deeper understanding of the entity’s performance, risks, and growth prospects.
The disclosures mandated by AS 17, covering segment revenue, results, assets, liabilities, capital expenditure, and non-cash expenses, ensure that stakeholders are not limited to consolidated figures that often mask significant variations between divisions. Instead, they gain insights into which segments are contributing to profits, which are underperforming, and how resources are being deployed across different areas of operation.
While the implementation of AS 17 comes with challenges such as allocation of common costs, transfer pricing of inter-segment transactions, and handling of unallocated assets and liabilities, the benefits far outweigh the difficulties. For investors, it offers clarity on profitability drivers and risks; for management, it provides a tool for performance evaluation and strategic decision-making; for regulators and creditors, it enhances transparency and reliability.
The global shift towards the management approach under IFRS 8 and Ind AS 108 highlights the evolving nature of segment reporting, aligning external reporting more closely with internal decision-making. Nevertheless, AS 17 continues to be highly relevant for enterprises not covered under Ind AS, serving as an important mechanism to meet the information needs of diverse stakeholders.
In essence, segment reporting bridges the gap between consolidated financial statements and the real dynamics of diversified and geographically spread enterprises. It fosters accountability, supports informed decisions, and contributes to the overall objective of financial reporting providing a true and fair view of an enterprise’s operations.