DOES THE “MANAGEMENT APPROACH” CONTRIBUTE TO SEGMENT REPORTING TRANSPARENCY?
January 4TH, 2010
An operating Segment is a component of an entity that may earn revenues or incur expenses, whose operating results are regularly reviewed by the chief operating decision maker (COMD) and for which discrete financial information is available.
Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments.
So, segment reporting creates an opportunity for companies to add value to the information they disseminate about their industry and geographic operations.
A major change occurred when FASB Statement No. 131 (SFAS 131) has replaced FASB Statement No. 14 (SFAS 14), as a result there was an important move from “standardized approach” to” management approach”.
As it is not feasible to provide all of that information in every set of financial statements. The SFAS 131 requires that general-purpose financial statements include selected information reported on a single basis of segmentation. The method the statement chose for determining what information to report is referred to as the “management approach”.
The “management approach” is based on the way that management organizes the segments within the enterprise for making operating decisions and assessing performance.
The new statement is more clearly based on the “management approach” and the company’s internal reporting to the entity’s chief operating decision maker (CODM). As a result, the new statement will enable investors to assess the company’s business performance from the same perspective used by the management in making decisions about operating matters.
Consequently, the segments are evident from the structure of the enterprise’s internal organization, and financial statement preparers should be able to provide the required information in a cost-effective and timely manner.
The “management approach” to segment reporting requires companies to report segment financial information consistent with the way they manage their businesses such as: measure of segment profit or loss and certain items included in determining segment profit or loss, segment assets, and certain related items.
Segment reporting should highlight the information and measures that management believes are important and are used to make key decisions. It should also provide a better link between the financial statements and the information reported in management commentaries such as the Operating and Financial Review or Management Discussion and Analysis.
Although management should provide information that addresses users’ needs, they often go to great lengths to avoid reporting transparent segment information. There are certainly legitimate reasons for concealing truly proprietary information that, if revealed, could injure the enterprise.
The resulting balancing act often leads managers to believe they, or the enterprise, are better served when information is not fully and transparently disclosed. Such actions harm both the enterprise and management by producing uncertainty, and inability of users to extract needed information which leads to higher perceived risk and increased capital costs.
The disclosure principle is that 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. According the SFAS 131 an enterprise shall disclose the following: 1.
Information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement 3.
Reconciliations of the totals of segment revenues, reported profit or...
References: 1. Jack W. Paul, James A. Largay III (2005). Does the “management approach” contribute to segment reporting transparency?, Business Horizons , 48, 303—310.
2. Ole-Kristian Hope, Tony Kang, Wayne B Thomas, and Florin Vasvari (2009). The effects of SFAS 131 geographic segment disclosures by US multinational companies on the valuation of foreign earnings, Journal of International Business Studies, 40, 421–443.
3. Financial Accounting Standards Board (1997). Disclosures about segments of an enterprise and related information. Statement of Financial Accounting Standards No. 131. Norwalk, CT7 FASB.
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