In order to enable the user to see the business “through the eyes of management’ by studying the of the financial statements, operating segment information has been made to be presented externally in the same way the information is presented to the top management of the entity internally, through the introduction of Standard 114 (AASB 114 Segment Reporting) by the Australian Accounting Standard Board. AASB 114 requires certain types of entities to present the financial information for primary and secondary segments identified by the entity. This paper presents a detailed description of the standard AASB 114 and its practical use in the case of a chosen entity Gunns Limited in Australia.
AASB 114 in scope and application is equivalent to International Accounting Standard (IAS) 14, Segment Reporting issued by the International Accounting Standards Board (IASB). “IAS 14 applies more narrowly to entities whose equity or debt securities are publicly traded and to entities that are in the process of issuing equity or debt securities in public securities markets”. (Comlaw.gov, 2004) Whereas AASB 114 is applicable to all entities which are required to prepare their financial reports in accordance with the provisions of Corporations Act, irrespective of whether their equity or securities are publicly traded or not (Bus, 2006).
Scope of AASB 14
AASB 114 deals with the segment reporting by each entity that is required to prepare and present a financial report according to the provisions of Part 2M 3 of the Corporations Act. However the standards do not apply to general purpose financial reports being prepared by not-for-profit entities. In order to study the improvements in the analysis of risks and returns by the disclosure requirements of AASB 114 it is important to have an in-depth knowledge of the salient features of the standard.
AASB prescribes the segment reporting in respect of business segment which is termed as the primary segment and geographical segment which is denoted as the secondary segment. The standard also provides clear and concise definitions of segment revenue, segment expense, segment result, segment assets, segment liabilities and segment accounting policies.
The reporting formats of primary and secondary segments are based on the fact that whether the predominant source and nature of risks and rewards of the entity have relationship with business segments or with geographical segments (Bus, 2006).
Determination of Business and Geographical Segments
In cases where the risks and rates of return of the entity is grossly determined by the differentiation in the products or services, then the primary reporting format is considered as the business segment. In this case the secondary reporting segment is based on geographical locations of the entity. On the other hand where the risks and rates of return of the entity are influenced by the location of the entity in different countries or geographical locations, then the primary reporting format is considered to be based on geographical locations and as a result the secondary reporting format becomes the business segments.
The segments of the entity in respect of which information reporting is done to the chief executive officer and the body which governs the affairs of the entity becomes the basis for the disclosure of information about the business and geographical segments.
The accounting policies adopted by the company become the foundation on which the segment information is required to be prepared.
The disclosure requirements described above contained in AASB 114 make the standard better equipped for analyzing the risks and rates of returns in view of the following distinctive characteristics.
In general the predominant source and nature of risks and the varying rates of returns the entity could generate can be identified by the structure of the internal organization and management of the entity and the system of reporting the entity adopts for presenting the information to the chief executive officer and the board of directors being the key management personnel with whom the conduct of the affairs of the entity is entrusted. According to Para 28 AASB considers that these internal structure and the reporting systems provide the best evidence of the predominant source of risks and returns of the entity and therefore adopts these as the basis of disclosure. To this extent AASB 114 is able to provide a better basis for analyzing the risks and returns of an entity, because the internal reporting system should normally bring out any inefficiencies and shortcomings in the system or in the reporting.
The considerations underlying the determination of formatting requirements of primary and secondary segments also make AASB 114 deal with the disclosure requirements differently so that the disclosures become meaningful and informative to the reader. Instead of following a rigid approach of prescribing the segment-wise primary reporting based on the products or services, the standard has provided a flexible approach. The rationale behind this prescription can be understood from the following discussion.
The operations of an entity consist of distinguishable components in the form of individual segments whether business or geographical (Chartered Accountants.com, 2008). Irrespective of the basis of identification the segments are subjected to varying risks and returns with each segment reacting differently to market situations producing varying degrees of risks and returns. Apart from the impact from the external factors, there is a close interaction among the different segments of the entity which also affects the risks and returns of the individual segments.
Characteristics of Business and Geographical Segments
By providing individual product or service or a group of related products or services, business segments become a distinguishable component of the entity. In order to determine whether a business segment is to be identified and whether products or services such segment represents are related or not it is essential to consider the following factors;
- nature of the product or service the segment represents,
- nature of the production process involved in producing the product or service,
- the type or class of customers being served by the product or service,
- the methods of distribution engaged for supplying the product or providing the service, and
- the nature of regulatory environment applicable to the supply of product or provision of the service (Compiled Accouting Standard, 2005).
By providing products or services within a specific economic environment, the geographical locations become distinguishable segments of an entity. Just as in the case of business segments there are different factors that need to be considered in the case of geographical segments. These factors include;
- similarity that exists among economic and political conditions,
- relationships that exist among operations in different geographical locations,
- proximity of operations,
- special types of risks associated with the operations being carried out in a specific geographical location,
- exchange control regulations affecting the transactions among the different locations and
- the currency risks underlying the transactions being carried out in a specific geographic location (Compiled Accouting Standard, 2005).
Analysis of Risks and Rates of Return
AASB 114 has made it clear that where the segment is sufficiently material to warrant separate disclosure, the business or geographical segment becomes reportable under the standard. For such determination the consideration of all the factors mentioned above is important. The standard has also provided that where a majority of the revenues earned from sales to external customers in the individual segment and in addition the threshold of 10% in respect of segment revenues, segment profit or loss, or segment assets is met (Australian Accounting Standards, 2008). By making it mandatory to consider all the relevant factors to determine the basis for segment-wise reporting AASB 114 has provided for a realistic analysis of risks and rates of returns from the business and geographical segments.
An extensive reporting format prescribed in respect of primary and secondary reporting segments has also made AASB 114 superior to the earlier standard prescribed in this respect. Para 50 to 66 specify the information to be disclosed in respect of each reportable segment which is to be reported using the primary segment reporting format. This information among other things include
- segment revenues making a distinction between sales to external customers and inter-segment transactions,
- segment results whether profit or loss resulting from transactions with external customers as well as from continuing and discontinued operations (CPA Australia, 2008).
The disclosure requirements also provide for a reconciliation being made between the information disclosed with respect to different reportable segments and the aggregated information contained in the financial reports of the entity. This reconciliation requirement is applicable with respect to segment revenues and total entity revenues, segment results and total entity results, segment assets and total entity assets and segment liabilities and total entity liabilities.
As compared to the previous standard of AASB 1005, AASB 114 can be considered to contain more accommodative provisions concerning disclosures by entities (dtf.wa.gov, 2005). For example, according to paragraph 4.7 of AASB 1005 only reportable segments qualify to be combined for reporting. Whereas in the case of AASB 114, there is no such restriction imposed on the entities. As such segments which otherwise could not be combined under AASB 1005 can be combined for reporting under AASB 114 (Australian Government, 2004).
Requirement of reporting of segment results of continuing and discontinued operations separately is uniquely available under AASB 114. Paragraphs 52, 52A and 67 require the disclosure of results from the continuing operations distinctly from the results of the operations which are discontinued concerning each reportable segment. AASB 1005 does not provide for such separate disclosures. To this extent AASB 114 provides more detailed information to the readers. Therefore disclosures under AASB 114 can be considered as more extensive and would be able to provide a meaningful analysis of risks and rates of returns enabling an informed judgment about the entity as a whole.
As a case study, this paper presents a note on the segment reporting by Gunns Limited.
Gunns Limited – an Overview
Founded in the year 1875, Gunns Limited is recognized as the world leader in forest management and forest certification. Gunns Limited is Australia’s largest integrated hardwood and softwood forest products company having three divisions;
- Forest products including forest plantations, wood fiber exports, and timber products,
- Management Investment Schemes which offer investors the opportunity to invest in woodlots and walnut lots and
- other businesses which include wineries, construction and Mitre 10 retail outlets (Gunns Limited, 2009).
The company is engaged in operations in pulpwood, veneer production, sawmilling and plantation establishment. The company employs more than 1600 people working in the business units of forestry, construction, cool climate wine production, Managed Investment scheme and hardware retail (Gunns Pulp Mill, 2005).
Segment Reporting by Gunns Limited
The company adopts the following definition and accounting policy in connection with segment reporting:
“A segment is a distinguishable component of the Project that is engaged either a business segment or based on the Project’s asset clauses within a particular geographical segment based on the geographical location of the assets, which is subject to risks and rewards that are different from those of other segments” – (Annual Report, 2009)
The Annual Report of Gunns Limited for the year 2009 presents segment reporting as a part of notes to the financial statements. The company has adopted its major business divisions – forest products, Managed Investment Schemes and Other businesses – as the primary reporting segments. Geographical segments form the secondary reporting segments.
The company has identified the segments for reporting as below:
Primary Reporting – Business Segments
Based on the internal management reporting system of the company, being the consolidated entity, the following main business segments have been identified for reporting:
Forest Products – This segment includes the operations covering the management of forestry and processing of forestry products, manufacture and sale of timber, veneers, wood chips and other ancillary products in the area of forestry business.
Managed Investment Schemes – This segment covers “establishment and financing of managed woodlot, vinelots and orchards and the provision of related forestry and horticultural services”. (AnnualReport, 2009)
Other Businesses including merchandising, construction services, vineyard management and wine production and sale.
Secondary Reporting – Geographical Segments
Gunns Limited has adopted geographical segments for its secondary reporting meeting the requirements of AASB 114. The financial results for the year 2009 have been presented based on the geographical segments. The company has reported segment revenues based on the geographical locations of the customers and the reporting on segment assets has been done based on the geographic location of assets. The geographical segments of the consolidated entity are arrived at as below:
Asia – This segment covers sale of forest products and wine in the Asian region
Australia and New Zealand – “manufacture and sale of forest products, establishment of managed woodlots, vinelots and orchards and provision of related forestry and horticultural services; sale of building materials and hardware products, provision of construction services, vineyard management and wine production and sale” (Annual Report, 2009).
Gunns Limited has reported segment-wise assets and liabilities based upon the use of such specific assets and liabilities by the individual segments. Tax assets and liabilities could not be assigned to specific segments and therefore they have remained unallocated to individual segments.
The company specifically reports in the basis of preparation that AASB 8 ‘Operating Segments’ replaces the present system of segment reporting under AASB 114 Segment Reporting. Since the new standard becomes applicable to annual reporting for periods after 1st January 2009, the segment reporting in the annual report for the financial year ending 30th June 2009 was compiled as per the provisions of AASB 114. The company also states that since the standard is concerned only with disclosure of financial information such change is not expected to result in any serious impact on the financial results of the company (Annual Financial Report, 2004).
In the statement of significant accounting policies it is reported that AASB 8 ‘Operating Segments’ introduces ‘management approach’ which makes it mandatory for the consolidated entity to disclose in the financial statements segment information based on the same methods by which the Chief Operating Decision Maker reviews the internal reports on the performance of different business segments for the purpose of assessing the performance of the segments and allocating resources to such segments (AnnualReport, 2007).
This method of reporting on the performance of segments ensures that the reader of the financial statement gets an overview of the business and a realistic assessment of segment-wise performance of the consolidated entity. Such an understanding of the segment-wise business results enables the investor or any other party dealing with the company to make meaningful financial decisions. The presentation of financial information pertaining to each segment enhances the scope of the review of operations of the company and it also deters the management to restrain from making any fictitious adjustments to the financial results or indulging in earning management.
A comparison of the financial performance of each segment in the current period with the performance in the corresponding previous period would throw out any abnormalities in the reporting or in the actual performance.
In accordance with the AASB 114 disclosure requirements, the segment reporting of Gunns Limited for the year ending 30th June 2009 has included segment revenue from continuing and discontinued operations under primary reporting. Net segment results representing net income or net loss are shown in respect of both continuing and discontinued operations separately with respect to each business segment described above.
Segment assets for each business segment showing unallocated assets and consolidated total assets form part of the reporting requirement. A similar presentation is prescribed for segment liabilities, which is followed by the company in the segment reporting. Other segment information includes capital expenditure incurred during the period in respect of each business segment, depreciation and amortization, and change in the value of biological assets.
Secondary reporting also follows a similar presentation of financial information for each geographical segment identified by the company and is being used for internal reporting to the CEO or other chief decision making authority and the board of directors.
Consideration of Economic Conditions
The geographical segment under AASB 114 is identified to be the individual components of an entity which is used to look after the supply of products or provision of services within specific geographical areas being impacted by prevailing economic conditions. In deciding the geographical segments, similarity of economic and political conditions is one of the factors that needs consideration.
With the present economic downturn prevailing globally, it needs considerable judgment while arriving at the economic similarity. When evaluating this factor the entity may have to consider long-term average gross margins or other metrics such as sales, sales growth trends, return on assets, operating cash flows and capital investment. While taking any of these metrics into account the entity may have to ensure that these measures for each segment fall within a close range or move in the same way in response to prevailing economic conditions.
In the present economic situation Gunns Limited would have faced a significant challenge in consolidating the secondary segment reporting with the geographic segments of Asia and Australia and New Zealand identified by it, as these geographical locations would not have moved in the close range in comparison to each other. Moreover the company has dealt with more product lines in the Australia and New Zealand segment as compared with Asia and this may also vitiate the segment-wise reporting by Gunns Limited.
Shortcoming of Segment Reporting under AASB 114
Nature of segments identified for reporting by the entities are often open to judgment by the entities concerned and is more of qualitative in nature. This makes the reporting more often an exercise of bifurcating the total results into arbitrary segments decided by the entity. The mode of deciding on the segments without a uniform approach makes the reporting lose its practical value.
The consideration of the geographical segments for secondary reporting suffers from the bias of different economic conditions prevailing in the respective economic zones where qualitative factors such as competitive and operating risks, currency risks and political conditions operate on the segment activities in addition to quantitative factors. Quite often the management may not be able to perceive the impact of these qualitative factors which affects the comparability of the segment-wise results. This impedes the use of secondary segment reporting when made on geographical location basis.
Another issue with segment reporting is the identification of the chief officer with decision making authority in complex organizations which makes the application of segment reporting difficult. In addition the person or authority reviewing the segment wise performance usually consider several other information, such as management planning details, board reports and other internal information, which may not be made available to the external users. Studying the segment reports without this additional information may prove futile.
AASB 114 was introduced with the objective of enabling the user to get operating segment-wise financial information to make meaningful decisions. Segment reporting ensures that information about different types of products and services an entity produces or deals with and the different geographical areas in which the entity operates are presented to the users. Segment-wise financial information is intended to provide better understanding of the past performance of the entity.
It also enables the user to make a better assessment of the risks and returns of the entity and through such assessment, the users would be able to make more informed and meaningful judgments about the entity as a whole. It is to be appreciated that many of the entities deal with groups of products and services or operate in different geographical locations resulting in differing rates of profitability and providing varying growth opportunities to the entity (AASB.com, 2005). The future prospects and risks for the entity also differ from product to product and from each geographical location to the other. Such financial information on the different products and services and pertaining to different geographical locations become important for assessing the risks and returns of a multinational organization having diversified business operations.
It is not easy to make such an assessment from the aggregate data contained in the financial statements being presented normally. Therefore presentation of segment-wise financial and other information are considered necessary for meeting the varied needs of the users of financial statement. It can reasonably be stated that AASB 114 has achieved its objective in enabling the users to make well-informed judgments by requiring entities to present segment-wise information.
AASB.com, 2005. Compiled Accounting Standard AASB 114: Segment Reporting. Web.
AnnualFinancialReport2004, 2004. Gunns Plantattions Woodlot Project 2004. Web.
AnnualReport, 2007. Gunns Limited. Web.
AnnualReport, 2009. Gunn Limited. Gunn Limited Australia.
AustralianAccountingStandards, 2008. AASB 114 Segment Reporting Fact Sheet. Web.
AustralianGovernment, 2004. Accounting Standard AASB 114: Segment Reporting. Web.
Bus, C.P.B., 2006. GAAP Alert No 4/2006. Web.
CharteredAccountants.com, 2008. AASB 114 – Segment Reporting. Web.
Comlaw. 2004. AASB 114: Segment Reporting. Web.
CompiledAccoutingStandard, 2005. AASB 114: Segment Reporting. Web.
CPAAustralia, 2008. AASB 114 Segment Reporting. Web.
dtf.wa. 2005. AASB 114 Segment Reporting Summary. Webn.
GunnsLimited, 2009. gunns.com – About Gunns. Web.
GunnsPulpMill, 2005. Bell Bay Pulp Mill – Corporate Overview. Web.