Calculate and Interpret Segment Ratios

To gain a detailed understanding of a company, it is necessary to evaluate the performance of its individual business segments, i.e., its subsidiaries, operating units, and operations in different geographical areas. This evaluation is facilitated by the fact that both IFRS and US GAAP require segment information to be provided in a company’s financial statements.

Requirements for Segment Reporting

• A company must disclose information relating to any operating segment which meets certain quantitative criteria. In this instance, the segment must constitute 10 percent or more of the combined operating segments’ revenue, assets, or profit.
• If after the application of certain quantitative criteria, the combined revenue from external customers for all reportable segments combined is less than 75 percent of the total company revenue, a company must identify additional reportable segments until the 75 percent level is attained.
• Small business segments may be merged into one if they share a substantial number of factors that define a business or geographical segment. Alternatively, they may be combined with a similar significant reportable segment.
• Information on operating segments and businesses that are not reportable should be combined in an “all other segments” category.
• Companies must disclose the factors that were considered in the identification of reportable segments. Besides, they must reveal the types of products and services sold by each of the reportable segments.
• For each reportable segment, a company must disclose the following:
  • a measure of profit/loss;
  • a measure of total assets and total liabilities;
  • segment revenue, which distinguishes between revenue to external customers and revenue from other segments;
  • interest revenue and expense;
  • cost of property, plant, and equipment, and any intangible assets acquired;
  • depreciation and amortization expense;
  • other non-cash expenses;
  • income tax expense/income; and
  • the share of the net profit/loss of investment is accounted for under the equity method.
• Companies must provide a reconciliation between the information on reportable segments and the consolidated financial statements in terms of segment revenue, profit or loss, assets, and liabilities.
• Companies must disclose if any single customer represents 10 percent or more of the company’s total revenues.

Segment Ratios

A variety of ratios may be computed based on the segment information that companies are required to report. The most common ones are described below.

• Segment Margin

Computation: segment profit (loss)/segment revenue

Interpretation: this measures the operating profitability of the segment relative to revenues.

• Segment Turnover

Computation: segment revenue/segment assets

Interpretation: this measures the overall efficiency of the segment, i.e., how much revenue is generated per unit of assets.

• Segment ROA

Computation: segment profit (loss)/segment assets

Interpretation: this measures the operating profitability of the segment relative to assets.

• Segment Debt Ratio

Computation: segment liabilities/segment assets

Interpretation: this examines the level of liabilities of the segment, i.e., its solvency.

Question 1

Which of the following is least likely a requirement under segment reporting?

1. A cash flow statement for each reportable segment.
2. Interest revenue and interest expense for each reportable segment.
3. The factors that were considered in the identification of the reportable segments and the types of products and services sold by each reportable segment.

Solution

The correct answer is A.

Under either IFRS or US GAAP, a company is not required to provide a cash flow statement for each of its reportable segments.

Companies must, however, disclose the factors which were considered in the identification of their reportable segments. Further, they must disclose the types of products and services that are sold by each reportable segment (option C). Finally, companies have to declare the interest revenue and interest expense for each reportable segment (option B).

Question 2

A conglomerate owns subsidiaries working in the following segments:

$$ \begin{array}{c|c}
\textbf{Segment} & \bf{ \text{% Participation in the} \\ \text{conglomerate’s revenue}} \\ \hline
\text{Mining} & {20\%} \\ \hline
\text{Consumer care products} & {30\%} \\ \hline
\text{Media} & {25\%} \\ \hline
\text{Electronics} & {10\%} \\ \hline
\text{Shipping} & {7\%} \\ \hline
\text{Construction} & {8\%} \\
\end{array} $$

What is the minimum number of fields the conglomerate needs to disclose with full details?

1. 3
2. 4
3. 5

Solution

The correct answer is B.

The conglomerate needs to disclose the full details fields of all the segments which contribute to at least 75% of its revenue. The condition applies to the 3 segments which are mining, consumer care products, and media.

In addition to what was previously mentioned, the company needs to disclose full details of segments contributing to 10% or more to its total revenue. This, therefore, requires us to add the electronics segment.

These disclosure criteria require detailed disclosure of mining, consumer products, media, and electronics, which sums up to 4 segments.