Similar economic characteristics – This is part of IFRS 8 Operating segments.
When evaluating whether two segments have similar economic characteristics, the difference between their gross margins should be measured by their percentage difference, as illustrated in the example below.
Long-term average gross margin analysis
Assume that operating segment A and operating segment B have long-term (usually a period of three to five years) average gross margins of 25 percent and 20 percent, respectively. When an entity evaluates whether these two segments have similar economic characteristics, the difference that it evaluates would not be 5 percent (25% – 20% = 5%).
Instead, the difference in gross margins is 25 percent [(25% – 20%) ÷ 20% = 25%], which would not be considered an immaterial difference when evaluating the aggregation criteria.
Differences in current-year margins between operating segments may not preclude aggregation if the segments are expected to have similar long-term average gross margins and other trends in the future. However, it is more difficult to demonstrate that operating segments are expected to have similar long-term average gross margins when the gross margins have not been historically similar. Similar economic characteristics
Likewise, two operating segments that have similar gross margins in the current year, but are expected to have dissimilar gross margins in the future, should not be aggregated.
Gross margin is used because it is less likely to be impacted by allocations. However, factors to consider in evaluating the economic similarities of operating segments will vary by entity and by industry. Prioritizing certain economic characteristics is a matter of judgment for management that will depend on the particular facts and circumstances of each situation. With that in mind, when determining economic similarities between operating segments, management may consider evaluating historical and long-term trends in the following items:
- Revenue Similar economic characteristics
- Cash flows Similar economic characteristics
- Gross profit Similar economic characteristics
- Segment profit or loss
- Costs of goods sold
- Major cost components
- Net income or loss
If management cannot reliably estimate far into the future, it may be inappropriate to assert that operating metrics that are not aligned will converge over an unreasonably long period of time. Any analysis of long-term economic similarities between operating segments being evaluated for aggregation should be consistent with historical results and with assumptions used for other accounting considerations, such as intangible asset impairment or realization of net deferred tax assets.
From research it shows that a large number of companies disclose only one segment!
A common argument found for reporting only one segment is that the operations are monitored at group level. The generic arguments keep coming back, with slight variations. An example that is recurring, with more or less the same content, is:
‘The company has to identify the level at which the company’s most senior executive decision-maker makes regular reviews of sales and operating income. These levels are defined as segments. The company’s most senior executive decision-maker is the company’s CEO. The regular internal reporting of income to the CEO, which fulfils the criteria to constitute a segment, is done for the Group as a whole, and we therefore report the total Group as the company’s only segment.’
The quote above is collected from a company that operates in 14 countries, promoting at least two different sets of products. The question that might come to one’s mind is ‘Shouldn’t this company monitor and evaluate their operations in more detail than at group level?’.
Another interesting argument for disclosing only one segment is:
‘The Company’s top executive decision-makers govern and manage the operations based on legal corporations. The number of legal corporations within the Company is about 60, and so, according to the IFRS 8 standard, the Group has that number of segments. Because the presentation of 60 segments would entail excessively detailed information, the standard proposes aggregating these at a suitable level if there are similar economic characteristics and the segments resemble one another. We cannot see how such an aggregation, into no more than ten segments, could be done so that the information was comprehensible. Thus the Company has chosen to aggregate all segments into a main segment.’
In this case the rationale for displaying only one segment is that each operating segment is so different in character that aggregation is not possible. The CODM in this entity was not clearly identified, which might be a factor for not monitoring the operations on a more aggregated level. The argument is hardly acceptable in that surely some detail must be better than no detail at all.