When you analyze the financial results of a company, operating segment information can be very insightful. This is where financial accounting and management accounting meet, where the external reporting largely aligns with the internal reporting. It’s an opportunity for a company to provide transparent, useful information to investors. What a company might call a business unit or division internally, is called operating segment or reportable segment in external reporting.

⏱️TIMESTAMPS⏱️
00:00 Introduction to operating segments
00:31 Segment reporting examples
04:28 ASC280 IFRS8 operating segments
05:08 Operating segment definition
06:02 Chief operating decision maker
06:38 Discrete financial information
07:20 Operating segment quantitative tests
08:49 Operating segment vs reportable segment
10:01 IFRS 8 core principle

What are the accounting principles and rules that regulate segment reporting? Under US Generally Accepted Accounting Principles, #ASC280 is the place to go. Under International Financial Reporting Standards, #IFRS8. These standards are largely converged, in other ways they treat the topic roughly the same. Both standards are based on a “management approach” to identifying and measuring the financial performance of an entity’s operating segments. Reported segment information will be based on the information used internally by management.

What is the definition of an operating segment? According to ASC 280, an operating segment is a component of a public entity (an entity whose equity or debt securities are publicly traded) that has all of the following characteristics:
It engages in business activities from which it may recognize revenues and incur expenses
Its operating results are regularly reviewed by the public entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance
Its discrete financial information is available

In segment reporting, there are three quantitative tests that companies perform: the 10% test, the practical limit test of 10, and the 75% test.

The 10% test. A public entity shall report separately information about an operating segment that meets any of the following quantitative thresholds:
Its reported revenue, including both sales to external customers and intersegment sales or transfers, is 10 percent or more of the combined revenue, internal and external, of all operating segments.
The absolute amount of its reported profit or loss is 10 percent or more of the greater of either the combined reported profit of all operating segments that did not report a loss, or the combined reported loss of all operating segments that did report a loss.
Its assets are 10 percent or more of the combined assets of all operating segments.
Operating segments that do not meet any of the quantitative thresholds may be considered reportable, and separately disclosed, if management believes that information about the segment would be useful to readers of the financial statements. So there are suggested thresholds for disclosure, but even if an operating segment does not meet any of the quantitative criteria, a company could choose to report it separately. Alternatively, two or more operating segments may be aggregated into one reportable segment if they have similar economic characteristics (as in: the range of the entity’s business activities and the economic environments in which it operates).

If the number of segments rises above 10, the entity should consider whether a practical limit has been reached. This limit is logically connected to the previous test, as 10 segments that each meet the 10% test one way or another will get you to around 100% of the business results.

A real “hard limit” test is the 75% test: a company needs to report additional segments if external revenue of all segments is less than 75% of consolidated revenue. Adding additional segments decreases the “all other segments” category, and needs to get the sum of the reported segments’ revenue above the 75%.

What’s the core principle behind #operatingsegment reporting? An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.

Philip de Vroe (The Finance Storyteller) aims to make accounting, finance and investing enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers finance training in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!

Want to get access to bonus content, and/or express your gratitude by buying me a cup of tea? Join my channel as a member through https://www.youtube.com/channel/UCQQJnyU8fALcOqqpyyIN4sg/join