OPERATING SEGMENT IFRS 8 & RELATED PARTY DISCLOSURES IAS 24

Users of financial statements will normally expect the financial statements to reflect transactions that
have taken place on normal commercial terms (arm’s length)

The users of financial statements would want to be informed if:

 Transactions have taken place that were not at arm’s length

 There are parties that could enforce transactions on the entity that are not on arm’s length basis.

To explain further, an entity might sell goods to its parent or fellow subsidiaries on more favorable terms
than to other customers or a parent company may make supplies to a subsidiary that was not
performing well, on more favorable terms than it would to other companies. This would boost the
apparent profitability of that subsidiary.

From the above analysis, the financial statement presented will be misleading because of the related
party dealings..

1.1 OBJECTIVE OF IAS 24

The objective of IAS 24 is to ensure that an entity’s financial statements contain sufficient disclosures
to draw attention to the possibility that the entity’s financial position, or profit or loss may have been
affected by: (a) the existence of related parties; and (b) transactions and outstanding balances with
related parties.
1.2 DEFINITIONS
1.2.1 RELATED PARTY

A party is related to an entity if the following conditions exist:

 The party controls the entity or is controlled by it

 It has significant influence over the entity
 The party is a close family member. These are family members who may be expected to influence
or be influenced by those running the affairs of the entity. They include: an individual partner
(spouse), children, dependents, children of individual partner.
 The party is a member of the key management personnel of the entity or its parent
 It has a joint control over the entity
 The party is an associate
 The party is a joint venture in which the entity is a venture.

A parent company is related to its subsidiaries, associate and fellow subsidiaries are related because they
are under common control.

1.2.2 Entities that are not usually related

 Trade unions
 Public utilities
 Two venturers that only share joint control over a joint venture
  Government departments and agencies
 Customers, suppliers, distributors and agents that an entity transacts business with.
1.2.3 RELATED PARTY TRANSACTIONS

The transactions common with related party dealing is a transfer of resources, services, or obligations
between related parties and whether or not a price is charged.

IAS 24 specifies the followings as related party transactions:

 Purchase or sales of goods

 Leases
 Rendering or receiving of services
 Purchases or sales of property and other assets
 Transfer of research and development costs
 Finance arrangement (loans or equity)
 Provision of guarantees
 Settlement of liabilities on behalf of the entity.

A common example of related party transactions. Suppose Mr. and Mrs. Peter are husband and wife and
are both Directors of Premier Designs Nig. Ltd. The company make purchase from Swift Net worth ltd one
of their subsidiaries that is controlled by Mrs. Emilia their daughter in-law. From the above narrative, Mr.
and Mrs Peter are related party to Swift Net worth ltd because they are key management staff of the
entity. Swift Net worth Ltd is related to to Premier Designs Nig. Ltd because it is jointly controlled by key
management of Swift Net worth Ltd.

1.3 DISCOSURE REQUIREMENTS

The IAS 24 requires disclosure to be made as note to the financial statements of the following, whether
transaction has taken place or not.

 The name of the entity’s parent

 The name of the ultimate parent if different
 The nature of the relationship
 The amount of transactions
 If there are outstanding balances, the amount must be stated, the terms and conditions,
provision for doubtful debt if any, the expense recognized in the period in respect of irrecoverable
debts due from related parties..

The above disclosures should be given separately on each of the following related parties:

 The parent
 subsidiary
 Associates
 Joint ventures in which the entity is a venture
 Key management personnel of the entity or its parent
  Other related party

Lastly, IAS 24 also requires disclosure of compensation to key management personnel. The required
disclosures are Short term employment benefits, Post-employment benefits, other long term benefits,
termination benefits and share based payment.

IFRS 8 OPERATING SEGMENT

IFRS 8 requires an entity to report financial and descriptive information about its reportable segments
because many companies operate in several industries with diversified operations across many
geographical locations. The diversification will result in different rates of profitability, growth prospects
and different levels of risk. The main objective of reporting on operations of different segments of a
company is to enable users of financial statements to carry out ratio analysis, identification of trends and
making of necessary predictions about the future. Absence of operating segment report, some poorly
operated segment of an entity may hide under the cover of those that are performing well.

It is only publicly quoted companies that are required to report on operating segment.

1.1 Definitions
IFRS 8 defines operating segment as part of an entity:
 That engages in business activities from which it earns revenue and incurs expenses
 Whose operating result are regularly reviewed by the entity’s chief operating decision maker
 With available discrete financial information.
 Operating segment: This is a component of an entity that engages in business activities
from which it may earn revenue and incurs expenses. Operating segment can also be
referred to as a component of an entity whose operating results are regularly reviewed
by the entity’s chief operating decision maker to make decisions about resources to be
allocated to the segment and assess its performance. Also it can be described as a
component of an entity for which discrete financial information is available.
 Reportable segment: This is an operating segment that its material information like
revenue, assets, liabilities, profits or losses among others needs to be provided in the
notes to the financial statements for performance assessment purposes. That is an
operating segment that its discrete financial information must be provided to users.
 Chief 0perating Decision Maker: This is an officer who identifies a function for allocation
of resources and assessment of performance of the operating segments for an entity and
not necessarily a manager with a specific title.

Note that the corporate head office of an entity is not usually regarded as an operating segment because
it does not earn revenue. IFRS 8 requires that the report from all segments must be reviewed by the Chief
Operating Decision Maker.
SEGMENT NOT YET GENERATING REVENUE:

IFRS 8 requires that a segment which engages in business activities for some time before it start generate
revenue should be regarded as an operating segment during the operating stage provided that it meets
other criteria. That is, it should be regarded as an operating segment provided it has discrete financial
information that is reviewed by the chief operating decision maker in making decisions assessing
operating performance.

1.2 AGGREGATION OF SEGMENTS

Two or more operating segment may be aggregated together if the segments have similar economic
characteristics as follows:

 The nature of products or services is similar

 The nature of their production process is similar
 The types and class of customer for their products or services are similar
 The methods used in the distribution of their product are similar
 If applicable, the nature of the regulatory environment is similar like banking, Insurance or public
utilities.
 The aggregation is consistent with the core principle of IFRS 8 “Operating segment”.
1.3 DETERMINATION OF REPORTABLE SEGMENT.

A separate report or information about an operating segment must be given if the following conditions
are met:

 If the segment’s total revenue including inter-segment sales or transfers is 10% or more of the
entity’s total revenue from all the operating segments.
 If the segment’s total assets is 10% or more of the entity’s total assets of all operating segments.
 If the segment’s profit is 10% or more to the entity’s total profit of all operating segments that
reported profit. Or if the segment reported loss is 10% or more of the entity’s total loss of all
operating segments that reported loss.
1.4 EXCEPTIONS TO THE 10% THRESHOLD

The total external revenue of all the identified reportable segments must not be less than 75% of the
entity’s total external revenue. If the external revenue of all the identified segments is less than 75% of
the entity’s external revenue, additional operating segments must be identified as reportable segment
(even if it does not meet the 10% threshold). Two or more operating segments below the 10% threshold
may be aggregated to produce a reportable segment if the segments have similar economic
characteristics and the segments are similar in majority of the aggregation criteria. Operating segments
that do not meet any of the quantitative thresholds (10%) may be considered reportable, and separately
disclosed if management believes that information about the segment would be useful to users of the
financial statements.
OPERATING SEGMENT REPORTED IN THE PRECEEDING PERIOD THAT IS NO LONGER REPORTABLE IN THE
CURRENT PERIOD:

In a situation whereby a company that was considered as a reportable segment in the period it met the
10% thresholds but was not qualified to be identified as a reportable segment in the current period for
not meeting the 10% thresholds. When this happens, IFRS 8 requires that such operating segment should
continue to be reported in the current period if the directors conclude that the operating segment is of
continuing significance.

1.5 INFORMATION TO BE REPORTED/DISCLOSED

IFRS 8 Requires that the information on financial statements to be disclosed should be such that users
and management uses for evaluating segment performance, and taking decision on how to allocate
resources to the operating segment. Such are information to be disclosed are:

 Revenue from external customers

 Investment income and finance cost if any
 Revenues from transactions with other operating segments of the same entity
 Interest revenue
 Depreciation and amortization charges
 Interest expense
 Material items of income and expense in line with IAS 1
 income tax expense
 A measure of profit or loss
 Assets
 Liabilities
 The amount of investment in associates and joint ventures
1.6 DISCLOSURE REQUIREMENT
 Revenue from external customers for each product and service or each group of similar products
and services
 Revenue from external customers attributed to the entity’s country of domicile and attributed to
all foreign countries in total where revenue is made
 Non-current assets located in the country of domicile and located in all foreign countries in total
where the entity holds assets
 If revenue from any customer is more than 10% of total revenue then it must be disclosed along
with the total of revenues from these customers and the identity of the segment reporting the
revenue.

HOW TO DETERMINE THE 10% THRESHOLD

 Revenue test:
=Operating segment’s total revenue/Total revenue of all operating segments. Note that
Operating segment’s total revenue =Internal revenue + External revenue
 Total asset test
 = Operating segment’s total assets/Total assets of all operating segments.

PROFIT OR LOSS TEST

There are three steps in doing this:

 Determine the total profits of all segments that earned or made profit;
 Determine the total losses of all segments that incurred or made loss;
 Chose the higher of the two figures above whether it is profit or loss and use it to carry out profit
or loss test as follows; (a) profit making segments = Operating profit/the choice made in three
above (b) Loss segments = Operating segment loss/the choice made in three above.

ILUSTRATION

AP reports seven different business types to its Managing Director. In the most recent financial year, the
revenue of these seven operations, as a percentage of total revenue including revenue from internal
customers, were as follows:

Business % internal % external %Total

1 0 30 30

2 0 15 15

3 6 8 14

4 3 7 10

5 0 9 9

6 2 3 5

7 4 13 17

15 85 100

Required. Identify the reportable segments

Solution Comment

1 0 30 30 Reportable segment
2 0 15 15 Reportable segment
3 6 8 14 Reportable segment
4 3 7 10 Reportable segment
5 0 9 9 Not reportable segment
6 2 3 5 Not reportable segment
7 4 13 17 Reportable segment
Revenue from external customers of reportable segment is 70% divided by 85% = 82%. This is above the
75% rule, hence no additional segment needs to be identified.

QUESTION

Fagba limited has recently acquired four large subsidiaries. These subsidiaries manufacture products
which are of different lines from those of the parent company. The parent company manufactures
plastics and related products whereas the subsidiaries manufacture the following:

Product Location

Subsidiary 1 Textiles Kaduna

Subsidiary 2 Car Products Lagos

Subsidiary 3 Fashion garments Onitsha

Subsidiary 4 Furniture items Benin

The directors have purchased these subsidiaries in order to diversify their products base but do not have
any knowledge of the information required in financial statements regarding these subsidiaries other
than the statutory requirement. The directors of the company realized that there is a need to disclose
segmental information but do not understand what the term means or what the implications are for
published accounts.

You are required to:

 Explain to the directors the purpose of segmental reporting of financial information

 Explain to the directors the criteria which should be used to identify the separate
reportable segments.(illustrate your answer to the above information)
 Critically evaluate IFRS 8, Operating segments, setting out the major troubles with the
standard. (ICAN)

ILLUSTRATION 3: SEMILORE PLC

Semilore, a public limited company, has several hotel business segments which are currently reported in
its financial statements. Tobi plc is an international company which reports to management on the basis
of region. It does not currently report segmental information under IFRS 8 Operating segments. The
results of the regional segments for the year ended December 31, 2022 are as follows:

REVENUE

Region External Internal Segment results (P or L)Segment asset

Segment liabilities
 N’000 N’000 N’000 N’000
N’000

USA 850 400 170 7,500

2,000

ASIA 600 150 (30) 2,000

3,900

SOUTH AMERICA 350 525 (50) 1,800

1,600

EUROPE 100 350 (120) 6,000

2,400

WEST AFRICA 1,400 300 140 8,500

3,300

EAST AFRICA 250 470 90 3,000

1,700

NORTH AFRICA 650 325 (180) 1,200

2,550

SOUTH AFRICA 600 280 210 12,000

3,250

NORTH AMERICA 300 180 410 7,000

2,800

There were no significant itra-group balances in the segment assets and liabilities. The hotel businesses
are located in capital cities in the various regions, and the company sets individual performance
indicators for each business on its city location.

Required: Discuss the principles in IFRS 8 Operating segments for the determination of a company’s
reportable operating segments and how these principles would be applied for Semilore plc using the
information given above.

SOLUTION

Total internal revenue 2,980,000

Total external revenue 5,100,000

Total revenue 8,080,000

Total assets 49,000,000

Total profit of all segment that made profit = 170 +140+90+210+410 = 1,020,000

Total losses from segments that made loss = 30+50+120+180 = 380,000

75% of the company’s total external revenue = 75% x 5,100 = 3,825,000

 Revenue test: = Operating segment’s total revenue/Total revenue of all operating segments
(internal + external revenue)
 Operating segment revenue test:

USA 850+400/8080 X 100 15.5% Passed

ASIA 600+150/8080 X 100 9.3% Failed

South America 350+525/8080 X 100 10.8% Passed

Europe 100+350/8080 X 100 5.6% Failed

West Africa 1400+300/8080 X 100 21% Passed

East Africa 250+470/8080 X 100 8.9% Failed

North Africa 650+325/8080 x 100 12.1% Passed

South Africa 600+280/8080 x 100 10.9% Passed

North America 300+180/8080 x 100 5.9% Failed

 Total asset test

=Operating segment’s total assets/Total assets of all operating segments:

Operating Segment Total Asset Test:

USA 7500/49000X100 15.3% Passed

Asia 2000/49000x100 4.1% Failed

South America 1800/49000x100 3.7% Failed

Europe 6000/49000x100 12.2% Passed

West Africa 8500/49000x100 17.3% passed

East Africa 3000/49000x100 6.1% Failed

North Africa 1200/49000x100 2.4% Failed

South Africa 12000/49000x100 124.5% Passed

North America 7000/49000x100 14.3% Passed

 Profit or loss Test

Total profit of all segments that made the profit = 170+140+90+210+410 = 1,020,000,000

Total losses of all segments that made loss = 30+50+120++180 = 380,000,000

Since total profit from all segments that earned profit is higher than total loses, the total profit of
1,020million should be used in carrying the profit or loss test.

OPERATING SEGMENT PROFIT TEST

USA 170/1020 X 100 16.7% Passed

Asia 30/1020 x 100 2.9% Failed

South America 50/1020 x 100 4.9% Failed

Europe 120/1020 x 100 11.8% Passed

West Africa 140/1020 x 100 13,7% Passed

East Africa 90/1020 x 100 8.8% Failed

North Africa 180/1020 x 100 17.6% Passed

South Africa 210/1020 x 100 20.6% Passed

North America 410/1020 x 100 40.2% Passed

REPORTABLE SEGMENT EXTERNAL REVENUE

$’000

USA 850

South America 350

Europe 100

West Africa 1,400

North Africa 650

South Africa 600

North America 300

4,250

75% of total external revenue criteria

Since the reportable segment that passed the relevant tests above (4,250/5100 x 100 = 83.3%), this
should be reported in the note to the account.

OBJECTIVES OF OPERATING SEGMENTS

1. TO provide information about different types of business activities and economic environments
that a company operates in;
2. To increase transparency for creditors and investors, especially regarding the company’s most
important operating units;
3. A guide to how to relate with customers in order to maximize the value of each customer to the
business.