Most entities will be able to identify their operating segments easily by reference to the definition. However, when this is not the case, for example if the chief operating decision maker (CODM) uses more than one set of segment information, other factors may enable the operating segments to be identified.
Factors to consider in determining operating segments for a reporting entity are:
- the nature of the business activities of each component of the entity, the existence of managers responsible for them, and information presented to the board of directors.
- an operating segment will usually have a segment manager who is directly accountable to, and has regular contact with, the CODM to discuss the performance of the segment. However, a single manager may be the segment manager for more than one operating segment. If the characteristics in the definition quoted above apply to more than one set of components of an entity (e.g., to both products-based and geographical components) but there is only one set for which segment managers are held responsible, then that set constitutes the operating segments.
- when an entity has a matrix management structure resulting in two or more overlapping sets of components for which different segment managers are responsible and the CODM regularly reviews the operating results of both components, an entity must consider the core principle of the Standard in order to determine its operating segments.
To identify operating segments, four questions are required to be answered.
1. Who or what is the chief operating decision maker?
The term ‘chief operating decision maker’ defines a function rather than an individual with a specific title. The title or titles of the person(s) identified as CODM is not relevant, as long as it is the person(s) responsible for making strategic decisions about the entity’s segments. The function of the CODM is to allocate resources to and assess the operating results of the segments of an entity. The CODM could be an individual, such as the chief executive officer or the chief operating officer, or it could be a group of executives, like the board of directors or a management committee.
Assume that an entity has a president, a chief executive officer, and a chief operating officer. All three individuals serve on a management committee, which exists to make operating decisions related to the different business activities of the entity, and the committee operates on the basis of consensus among its members. In this case, the CODM would be the management committee itself. However, the fact that a management committee exists does not necessarily mean that the committee is the CODM. For example, if the chief executive officer can override the decisions made by the committee, then the chief executive officer may be the CODM, because the CODM essentially controls the management committee, and therefore the CODM has control over the operating decisions made. However, it is unlikely in practice to make any difference whether the management committee or the chief executive officer is regarded as the CODM, since the operating results information that is regularly reviewed by both is likely to be identical.
2. Does the identified component of an entity generate revenue and expenses?
Since the test is whether the component may earn revenues and incur expenses from its business activities, a start-up operation that has not yet earned revenues may be an operating segment, as may a component of an entity that sells primarily or exclusively to other components of the same entity. Conversely, operations, such as corporate treasury or headquarters, which generate no revenues or generate revenues that are only incidental to the activities of the entity, will not be operating segments.
Quantitative thresholds (IFRS 8 para 13)
Information on an operating segment should be separately reported if:
- reported revenue (external and inter-segment) is 10% or more of the combined revenue of all operating segments;
- the absolute amount of the segment’s reported profit or loss is 10% or more of the greater of:
- the combined reported profit of all operating segments that did not report a loss, and n the combined loss of all operating segments that reported a loss;
- the segment’s assets are 10% or more of the combined assets of all operating segments.
Two or more operating segments may be combined (aggregated) and reported as one if certain conditions are satisfied.
Aggregation of operating segments (IFRS 8 para 12)
Two or more operating segments may be combined as a single reportable segment if:
- aggregation provides financial statement users with information that allows them to evaluate the business and the environment in which it operates;
- they have similar economic characteristics; and
- they are similar in each of the following respects:
- the nature of the products and services,
- the nature of the production processes,
- the type or class of customer for their products and services,
- the methods used to distribute their products or provide their services, and
- the nature of the regulatory environment (ie, banking, insurance or public utilities), if applicable.
Minimum number of reportable segments
After determining the reportable segments, the entity should ensure that the total external revenue attributable to those reportable segments is at least 75% of the entity’s total revenue. When the 75% threshold is not met, additional reportable segments should be identified (even if they do not meet the 10% thresholds), until at least 75% of the entity’s total external revenue is included in its reportable segments.
3. Is discrete management information available for the identified component?
This refers to the financial information made available to the CODM for the purpose of reviewing performance and in determining how resources should be allocated. For a component to be an operating segment, the financial information about the operating results of the component should be sufficiently detailed to enable the CODM to make decisions about resources to be allocated and to assess its performance.
4. Is that management information regularly reviewed by the CODM?
A component of the entity that is regularly reviewed by the CODM is likely to be an operating segment. In practice, a key issue in identifying operating segments is the extent to which the operating results of business units are aggregated for the purpose of review by the CODM. In many cases, the CODM will receive and review information about the operating results of individual business units as well as of groups of business units, and it may be difficult to establish which set of information the CODM uses in order to make decisions about resources to be allocated and to assess performance. In these circumstances, IFRS 8 states that other factors may help identify a single set of components as constituting an entity’s operating segments, including the nature of the business activities of each component, the existence of managers responsible for them, and information presented to the board of directors. In this regard, IFRS 8 refers in particular to the role of what it describes as the ‘segment manager’.
The CODM may review one type of result based on product lines and another type based on geographic area. IFRS 8 states that, in these situations, operating segments should be determined based on the accountability for performance of the managers who report directly to the CODM. If the managers who report directly to the CODM each have responsibility for a particular product family, then each of those product families is an operating segment.
In a matrix management structure with dual or overlapping management responsibilities (e.g., product-based and geographical areas of responsibility) judgment may need to be exercised in identifying the set of operating segments that best applies the core principle of IFRS 8.