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Commission Regulation (EC) No 1725/2003 of 29 September 2003 adopting certain international accounting standards in accordance with Regulation (EC)   No 1606/2002 of the European Parliament and of the Council

Content

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Identifying reportable segments

Primary and secondary segment reporting formats

26. The dominant source and nature of an enterprise's risks and returns should govern whether its primary segment reporting format will be business segments or geographical segments. If the enterprise's risks and rates of return are affected predominantly by differences in the products and services it produces, its primary format for reporting segment information should be business segments, with secondary information reported geographically. Similarly, if the enterprise's risks and rates of return are affected predominantly by the fact that it operates in different countries or other geographical areas, its primary format for reporting segment information should be geographical segments, with secondary information reported for groups of related products and services.

27. An enterprise's internal organisational and management structure and its system of internal financial reporting to the board of directors and the chief executive officer should normally be the basis for identifying the predominant source and nature of risks and differing rates of return facing the enterprise and, therefore, for determining which reporting format is primary and which is secondary, except as provided in subparagraphs (a) and (b) below:

(a) if an enterprise's risks and rates of return are strongly affected both by differences in the products and services it produces and by differences in the geographical areas in which it operates, as evidenced by a "matrix approach" to managing the company and to reporting internally to the board of directors and the chief executive officer, then the enterprise should use business segments as its primary segment reporting format and geographical segments as its secondary reporting format; and

(b) if an enterprise's internal organisational and management structure and its system of internal financial reporting to the board of directors and the chief executive officer are based neither on individual products or services or on groups of related products/services nor on geography, the directors and management of the enterprise should determine whether the enterprise's risks and returns are related more to the products and services it produces or more to the geographical areas in which it operates and, as a consequence, should choose either business segments or geographical segments as the enterprise's primary segment reporting format, with the other as its secondary reporting format.

28. For most enterprises, the predominant source of risks and returns determines how the enterprise is organised and managed. An enterprise's organisational and management structure and its internal financial reporting system normally provide the best evidence of the enterprise's predominant source of risks and returns for purpose of its segment reporting. Therefore, except in rare circumstances, an enterprise will report segment information in its financial statements on the same basis as it reports internally to top management. Its predominant source of risks and returns becomes its primary segment reporting format. Its secondary source of risks and returns becomes its secondary segment reporting format.

29. A "matrix presentation" - both business segments and geographical segments as primary segment reporting formats with full segment disclosures on each basis - often will provide useful information if an enterprise's risks and rates of return are strongly affected both by differences in the products and services it produces and by differences in the geographical areas in which it operates. This Standard does not require, but does not prohibit, a "matrix presentation".

30. In some cases, an enterprise's organisation and internal reporting may have developed along lines unrelated either to differences in the types of products and services they produce or to the geographical areas in which they operate. For instance, internal reporting may be organised solely by legal entity, resulting in internal segments composed of groups of unrelated products and services. In those unusual cases, the internally reported segment data will not meet the objective of this Standard. Accordingly, paragraph 27(b) requires the directors and management of the enterprise to determine whether the enterprise's risks and returns are more product/service driven or geographically driven and to choose either business segments or geographical segments as the enterprise's primary basis of segment reporting. The objective is to achieve a reasonable degree of comparability with other enterprises, enhance understandability of the resulting information, and meet the expressed needs of investors, creditors, and others for information about product/service-related and geographically-related risks and returns.

Business and geographical segments

31. An enterprise's business and geographical segments for external reporting purposes should be those organisational units for which information is reported to the board of directors and to the chief executive officer for the purpose of evaluating the unit's past performance and for making decisions about future allocations of resources, except as provided in paragraph 32.

32. If an enterprise's internal organisational and management structure and its system of internal financial reporting to the board of directors and the chief executive officer are based neither on individual products or services or on groups of related products/services nor on geography, paragraph 27(b) requires that the directors and management of the enterprise should choose either business segments or geographical segments as the enterprise's primary segment reporting format based on their assessment of which reflects the primary source of the enterprise's risks and returns, with the other its secondary reporting format. In that case, the directors and management of the enterprise must determine its business segments and geographical segments for external reporting purposes based on the factors in the definitions in paragraph 9 of this Standard, rather than on the basis of its system of internal financial reporting to the board of directors and chief executive officer, consistent with the following:

(a) if one or more of the segments reported internally to the directors and management is a business segment or a geographical segment based on the factors in the definitions in paragraph 9 but others are not, subparagraph (b) should be applied only to those internal segments that do not meet the definitions in paragraph 9 (that is, an internally reported segment that meets the definition should not be further segmented);

(b) for those segments reported internally to the directors and management that do not satisfy the definitions in paragraph 9, management of the enterprise should look to the next lower level of internal segmentation that reports information along product and service lines or geographical lines, as appropriate under the definitions in paragraph 9; and

(c) if such an internally reported lower-level segment meets the definition of business segment or geographical segment based on the factors in paragraph 9, the criteria in paragraphs 34 and 35 for identifying reportable segments should be applied to that segment.

33. Under this Standard, most enterprises will identify their business and geographical segments as the organisational units for which information is reported to the board of directors (particularly the supervisory non-management directors, if any) and to the chief executive officer (the senior operating decision maker, which in some cases may be a group of several people) for the purpose of evaluating each unit's past performance and for making decisions about future allocations of resources. And even if an enterprise must apply paragraph 32 because its internal segments are not along product/service or geographical lines, it will look to the next lower level of internal segmentation that reports information along product and service lines or geographical lines rather than construct segments solely for external reporting purposes. This approach of looking to an enterprise's organisational and management structure and its internal financial reporting system to identify the enterprise's business and geographical segments for external reporting purposes is sometimes called the "management approach", and the organisational components for which information is reported internally are sometimes called "operating segments".

Reportable segments

34. Two or more internally reported business segments or geographical segments that are substantially similar may be combined as a single business segment or geographical segment. Two or more business segments or geographical segments are substantially similar only if:

(a) they exhibit similar long-term financial performance; and

(b) they are similar in all of the factors in the appropriate definition in paragraph 9.

35. A business segment or geographical segment should be identified as a reportable segment if a majority of its revenue is earned from sales to external customers and:

(a) its revenue from sales to external customers and from transactions with other segments is 10 % or more of the total revenue, external and internal, of all segments; or

(b) its segment result, whether profit or loss, is 10 % or more of the combined result of all segments in profit or the combined result of all segments in loss, whichever is the greater in absolute amount; or

(c) its assets are 10 % or more of the total assets of all segments.

36. If an internally reported segment is below all of the thresholds of significance in paragraph 35:

(a) that segment may be designated as a reportable segment despite its size;

(b) if not designated as a reportable segment despite its size, that segment may be combined into a separately reportable segment with one or more other similar internally reported segment(s) that are also below all of the thresholds of significance in paragraph 35 (two or more business segments or geographical segments are similar if they share a majority of the factors in the appropriate definition in paragraph 9); and

(c) if that segment is not separately reported or combined, it should be included as an unallocated reconciling item.

37. If total external revenue attributable to reportable segments constitutes less than 75 % of the total consolidated or enterprise revenue, additional segments should be identified as reportable segments, even if they do not meet the 10 % thresholds in paragraph 35, until at least 75 % of total consolidated or enterprise revenue is included in reportable segments.

38. The 10 % thresholds in this Standard are not intended to be a guide for determining materiality for any aspect of financial reporting other than identifying reportable business and geographical segments.

39. By limiting reportable segments to those that earn a majority of their revenue from sales to external customers, this Standard does not require that the different stages of vertically integrated operations be identified as separate business segments. However, in some industries, current practice is to report certain vertically integrated activities as separate business segments even if they do not generate significant external sales revenue. For instance, many international oil companies report their upstream activities (exploration and production) and their downstream activities (refining and marketing) as separate business segments even if most or all of the upstream product (crude petroleum) is transferred internally to the enterprise's refining operation.

40. This Standard encourages, but does not require, the voluntary reporting of vertically integrated activities as separate segments, with appropriate description including disclosure of the basis of pricing inter-segment transfers as required by paragraph 75.

41. If an enterprise's internal reporting system treats vertically integrated activities as separate segments and the enterprise does not choose to report them externally as business segments, the selling segment should be combined into the buying segment(s) in identifying externally reportable business segments unless there is no reasonable basis for doing so, in which case the selling segment would be included as an unallocated reconciling item.

42. A segment identified as a reportable segment in the immediately preceding period because it satisfied the relevant 10 % thresholds should continue to be a reportable segment for the current period notwithstanding that its revenue, result, and assets all no longer exceed the 10 % thresholds, if the management of the enterprise judges the segment to be of continuing significance.

43. If a segment is identified as a reportable segment in the current period because it satisfies the relevant 10 % thresholds, prior period segment data that is presented for comparative purposes should be restated to reflect the newly reportable segment as a separate segment, even if that segment did not satisfy the 10 % thresholds in the prior period, unless it is impracticable to do so.

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