Petrova Diana
Ph.D., Assoc. Professor
University of National and World Economy
Sofia, Bulgaria
USEFULNESS OF FINANCIAL REPORTING FOR OPERATING SEGMENTS OF COMPANIES IN CONDITIONS OF ECONOMIC GLOBALIZATION
In the contemporary conditions of economic globalization the number of diversified companies which operate in different economic fields and geographical areas is constantly increasing. This leads to a growing interest in disclosing disaggregated financial information for operating segments of companies. This information is exceptionally important for financial statements users as it gives them the opportunity to analyze thoroughly the past development of the company, to consider more accurately which activities have mostly contributed to the results achieved, to assess its future perspectives and to take grounded economic decisions. The lack of such detailed segmental information makes the financial statements less useful for the purposes of forecasting the future business activities of the company, for its future financial results, cash flows and the risks related to the same. As the different products and services of the company and its operations in different geographical areas are characterized by different rates of return, risks and possibilities for growth, it would be impossible to assess and analyze them if we use only the generalized financial statement information related to the activity and the results of the company in general. The main purpose of segmental reporting is to allow financial statements users to look behind the generalized totals to the individual components that constitute the company. The importance of the segmental information disclosed is proved by the results of numerous global researches evidencing that this is one of the most important disclosing for financial statements users. In response to the growing needs for information about the different business activities performed by companies as well as their operations in the different economic environments, the regulatory bodies in a number of countries continuously increase their requirements regarding segmental information disclosing. Financial reporting for the performance of operating segments of companies is a critical area of focus for investors and regulators in the contemporary global economic environment.
Financial information for operating segments provided by companies in accordance with the requirements set by International Financial Reporting Standard (IFRS) 8 Operating Segments is intended to enable financial statement users to evaluate the nature and financial effects of the business activities in which the company engages and the economic environments in which it operates. This standard specifies how a company should report information for its operating segments in financial statements and also sets out requirements for related disclosures about products and services, geographical areas and major customers. Financial information is required to be reported on the same basis as is used internally for evaluating operating segments performance and deciding how to allocate resources to operating segments. IFRS 8 Operating Segments requires companies to disclose segmental information in a manner consistent with the way that management regards the company, “through the eyes of management” (management approach).
Together with the directions given by IFRS 8 Operating Segments, the subjective opinions of the company management are of significant importance for the provision and presentation of financial segmental information. This is related to the philosophy which serves as the basis for standard requirements. When taking decisions about identifying the operating segments, the objects of rather subjective opinions are, for example, grouping the similarities and differences between products and services, differentiation of regions, risk characteristics of markets, potential for development and expected future significance of different segments, where the specific nature of the activity performed by the company plays a major role. It is crucial to bear in mind that these opinions should conform to the purpose of presenting financial segmental information. The basic purpose of segmental information reporting is to assist the financial statement users to understand better the activity of the company and to assess better its past and future development, therefore the company management undertakes the responsibility to define the best segmental reporting method and to provide the most useful information to users. In order to respond to the users’ needs and to be useful for the decision-making process, segmental information should have the following main qualitative characteristics: understandability, relevance, reliability and comparability.
Financial information for operating segments could not be useful for decision-making by users if they do not understand it. Therefore the company should make efforts to provide information which is not difficult to understand, to present it in a detailed way and with the necessary descriptions, allowing its correct interpretation and creating the right opinion for the activity of different segments.
Segmental information is regarded relevant when it affects the taking of economic decisions by users by helping them assess past, current or future events and confirming and correcting their previous assessments. It is extremely important for the segmental information to be suitable for making forecasts. The forecast and confirmation roles of accounting segmental information are interrelated. Information for operations already made can confirm the forecasts and objectives planned but is also important for forecasting future activities of the company.
Financial segmental information is reliable when it lacks material errors or bias and presents the activity of the company in a reliable way. Reliability also involves thoroughness and neutrality of information. If the selection or presentation of segmental information influences the decisions or opinions of users of information in order to achieve a predetermined result then the neutrality requirement is not met.
Comparability should be combined with relevance and reliability so that the usefulness of financial segmental information is increased. The possibility to compare segmental information of one and the same company about different periods or segmental information of a company with that of another is of great importance to the people who take decisions.
The requirements set by IFRS 8 Operating Segments aim at providing information having the abovementioned qualitative characteristics. The purpose of using these requirements is to respond to the needs of investors, creditors, contractors and other interested persons for information in order to assess the risks and return related to certain products, services, geographic areas in order to achieve a reasonable level of comparability and to increase the understandability of segmental information.
When discussing the problems related to provision and presentation of financial segmental information we should not forget the major restriction, namely that the benefits from information should exceed the costs for its provision. The accounting standards compilers, companies preparing financial statements as well as users of financial statement information need to conform to this restriction. Gathering, processing, classifying and presenting segmental information are expensive, therefore it is necessary to look for a balance between benefits and costs. One of the major problems in this field is to achieve the best possible combination of the interests of the company and of the external users of information. Some companies often state that detailed segmental information reporting requires significant additional efforts and costs and are concerned that in this way confidential information about the company is disclosed to the competition, which carries risks for the company and can affect its competitive positions in a negative way. However, the needs of financial statement users for segmental information are far greater since without it they would not be able to take grounded economic decisions. The burden of preparing segmental disclosures is relieved if the segmental information within the company internal management system for reporting corresponds to the method of defining operating segments for the purposes of external financial reporting.
References
1. Baker, R., Lembke, V., King, T., Advanced Financial Accounting, Sixth Edition, McGraw-Hill, New York, USA, 2005.
2. International Financial Reporting Standard (IFRS) 8 Operating Segments.
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