Lecture 7 Compulsory disclosures: Segments and

related parties
Lecture Outline
Segment reporting
1. Background
2. The current segment reporting standard AASB 8 the management
approach
3. The process step 1 identify operating segments
4. The process step 2 is the segment reportable?
5. The process step 3 preparing the disclosure
6. An example from Qantas
7. Reflections
Related party disclosures
1. The nature of related party disclosures
2. Related party disclosures: their rationale and significance
3. Limitations of related party disclosures

References
Current standard AASB 8 Operating Segments
Chapter 11
Readings pack Shanahan and Kruger
AASB 124
And also Chris Nobes interview MP3 file in lecture folder

Background: Segment Reporting & RPD
I hear a lot of you saying in class that CFS is needed in order to present a
true and fair view. Were going to increasingly question that over coming
weeks
Consolidated financial statements (CFS) are aggregated. Segment
reporting (SR) provides some complementary dis-aggregation while
related party disclosures (RPD) provide some insight into risky
transactions
From the 1960s onwards companies were increasingly diversified on
both an industry and geographical basis. Complex structures
Aggregated data may conceal information about risk. Geographical risk,
industry risk, subsidiary risk. Individual losses, debt levels and other
detail are lose in aggregation process. We cant see which products,
divisions, subsidiaries within the global group are doing well or poorly.
Maybe one part is earning huge profits which masks risks in other areas.
CFS may hamper ethical investing choice
Chris Nobes interview analysts want segment reporting, use it and make
better predictions with it
Segment reporting background
Early versions of segment reporting:
o Followed a battle in the 1970s between the standard setters and
large companies
o Outcome a qualitative definition of segment based on where are
the risks and returns in the group
o Many reporting entities responded by disclosing as little as
possible e.g. IBM argued that it only had one segment. A fear of
disclosure. Early versions of the accounting standard were clearly
not effective.
AASB 8 Operating segments issued Feb 2007 effective 1 January 2009
replaced AASB 114
AASB 8 more principles-based than AASB 114
Key change AASB 8 changed definition of segment from those parts of
the business where the key risks and returns are, to align with how
management (chief operating decision-makers) do their reporting

The management approach
AASB 8 required an entity to adopt the management approach
Information that the chief operating decision maker [CODM] uses
internally for evaluating segment for divisional performance
In using the management approach, we need disclosures of basis on
which segment information is prepared, and reconciliations to amounts
recognised in income statement and balance sheet
The steps
1. Identify the operating segments
2. Identify the reportable segments
3. Prepare the required segment reporting disclosure
4. Reconcile the SR with the main financials
5. Provide other required disclosures

Identifying Operating Segments: Step 1
Identify operating segments on the basis of internal reports regularly
reviewed by the chief operating decision maker [CODM] seeing
through the eyes of management
Advantages
o This new standard is already increasing the number of reported
segments and the amount of information disclosed
o Allows timely reporting at little extra cost
o Enhanced consistency with other parts of the annual report
o Gives insight into the mind of management
o Highlights risks & opportunities that management believes are
important
o May limit manipulative opportunism
o BUT may also limit cross-sectional comparability and lead to
information overload
What is an operating segment?
Para 5 A component of an entity:
(a) that engages in business activities
(b) whose operating results are regularly reviewed by the CODM
(c) for which discrete financial information is available
Note: (1) segments selling partly or wholly internally are included
(2) some parts of the entity may not be (classified as) operating segments e.g.
non-operating income and expenses such as interest revenue, directors fees,
dividend revenue. All general corporate items are reconciling items. General
corporate IS NOT A SEGMENT
PS: it is unlikely that an individual subsidiary will be an operating segment.
WHY/WHY NOT?

Which segments are Reportable?: Step 2
Which segments are reportable?
Apply the following test to all reportable segments (Para 13). Note, only one test
needs to be satisfied:
a) Revenue10% of combined revenue (external + internal) of all
segments OR
b) Absolute amount of P(L) 10% of the greater of the absolute amount
of total segment profits or losses OR
c) Assets10% of combined assets
To apply test (b):
- add up all the profits (of all the profitable segments); add up all losses (of
the loss-makers) and take your benchmark 10% of the greater of total
profits or total losses (ignoring signs)
- Compare each segments profit or loss (ignoring sign) to that bench mark
Qualifications/other issues:
- management may include a segment that does not meet the above tests if
it believes segment information will be useful to users
- more segments must be added if the total of external revenue of
reportable segments is < 75% of total entity revenue. In other words, the
standard setters want reporting entities to report a significant number of
segments
- And what do we do with the segments that fail the test? other
Prepare the required financial disclosures: step 3
For each reportable segment:
1. Disclosure of items required by paras 23-4 of AASB 8. Profit or loss, total
assets and liabilities, external and internal revenues, interest revenue &
expense, depreciation & amortisation, material income & expense items
as per AASB 101, interest in P/L of associates and joint ventures (equity
method), income tax expense or income if those items are regularly seen
by CODM or included in P/L
2. The basis of the measurement para 25 show us the same numbers the
CODM sees for each of the above
Reconciling segment disclosures to financial statements: Step 3
We must also disclose reconciliations explaining the difference between (para
28):
- Total reportable segment revenue & total entity revenue
- Total reportable segment pre-tax P/L & total entity P/L (add income tax if
available
- Total reportable segment assets & total entity assets
- Total reportable segment liabilities (if available) & total entity liabilities
- Total other material items of reportable segments & entity
Reconciling items will include:
- the values from non-reportable segments
- Amounts never allocated to segments in the first place
- Differences in accounting policies between segment & entity financial
statements
- Eliminations of intersegment revenues/profits
Other additional disclosures required:
- Geographic segmentation: revenue and assets dissected between country
of domicile and all foreign countries in total or by individual country if
material
- Data about reliance on major customers (i.e. making up 10% of entity
revenues)
- Example you are provided with the following internal
financial data from Lego Buildings Limited:
-
Based on the information provided to you, which of these operating divisions are
reportable segments under AASB 8?
Segment revenue test


















Example from section 11.6 of Chapter 11
The QST Ltd entity commenced operations on 1 January 20X0 and established
the following business units that report to the Chief Executive Officer: Textiles,
Construction and Finance
Step 1 is complete you have already assessed that all 3 divisions are reportable
segments
Revenues
The internal reporting system reported revenues for each segment as follows:
20X1 20X0
$000 $000
Textiles 10,608 7,310
Construction 6,770 3,730
Finance 5,300 4,160

Included in the revenue of the textiles was $2,100,000 (20X0: $1,500,000) of
sales to the construction segment. In addition, the turnover of the construction
segment included $1,200,000 (20X0:$800,000) of goods and services supplied to
the textiles and finance segments.
Expenses
The internal reporting system reported expenses for each segment as follows:
20X1 20X0
$000 $000
Textiles 9,248 6,640
Construction 6,005 3,380
Finance 5,190 4,108

Included in these reported expenses were the following items
Textiles Construction Finance
20X1 20X2 20X1 20X2 20X1 20X2
$000 $000 $000 $000 $000 $000
Depreciation and amortisation 1,500 720 300 280 210 95
Other non-case expenses 660 320 310 180 230 175
Interest expense 4,000 3,200

Assets, liabilities and additions for property, plant and equipment
The internal reporting system revealed the following assets, liabilities and
additions to property, plant and equipment (PPE) for each operating segment:
Assets Liabilities PPE additions
20X1 20X2 20X1 20X2 20X1 20X2
$000 $000 $000 $000 $000 $000
Textiles 11,218 6,347 570 400 1,200 700
Construction 3,350 3,000 1,300 1,400 300 420
Finance 1,981 530 900 210 230 120

As at 31 December 20X1 (20X0 the closing inventory of the construction
segment included unrealised profits of $1,300,000 ($550,000) in respect of
purchases from the textiles segment.
General corporate, borrowings and income tax
The general corporate activities including head office operations gave rise to the
following total and balances:
20X1 20X0
$000 $000
Interest revenue 55 28
Dividend revenue 200 200
Head office expense 700 326
Income tax expense 970 420
Head office assets 2,220 1,201
Borrowings 600 600
Income tax liabilities 800 500

Consolidated financial reports
The consolidated financial reports of the QSD Ltd entity for 31 December 20X1
and 31 December 20X0 include the following totals and balances:
20X1 20X0
Consolidated Consolidated
$000 $000
Profit before income tax expense 1,140 504
Income tax expense (745) (255)
Net profit 395 249

Total Assets 17,419 10,498
Total Liabilities 4,120 3,080









And the actual segment disclosure?


Questions to consider about the Qantas disclosure
What insight do we now have into the risks and returns within the group?
Where are segment assets and liabilities?
Significant changes from the way Qantas did it in 2012 a question raised
in the assignment asks you to think about why Qantas made these
changes. Presumably it wasnt the move from AASB 114 to AASB 8 as that
happened years ago.
How well can we now compare the risks and returns of two key
competitors; Qantas and Virgin?

Segment reporting: assessment
- Despite the change to the CODM approach, we are still reliant on
judgement, discretion and integrity of management
o There is still a great deal of aggregation
o Allocation problems are glossed over even if reconciliations are
provided, the impact on particular segments may be indeterminate
- Reliance on accounting system of reporting entities
- Comparability may be a problem (e,g. Qantas and Virgin) See also
comments in our interview with Chris Nobes on comparability
- A question for you could you develop a better rule for determining
reportable segments?
Segment reporting: more reflection
Management may avoid risky ventures as they may be too hard to hide
May reveal too much to competitors if segment results look good
Or result in a take-over if segment results are not so good
In general, it may attract unwanted attention corporations have an
innate fear of disclosure

In still keeping with the theme of disaggregation:
Related Party Disclosures AASB 124
1. Related Party Disclosures Nature
Accounting relies on arms-length transactions between independent
parties to provide robust (objective, verifiable) data. Related party
transactions [RPT] are, by definition, not at arms length
As such, the transaction may not have been at fair value and so many not
have been in the best interests of the company
And so AASB 124 requires disclosures of all transactions between the
entity and its related parties
A related party can be a person or a company. AASB 124 para 9 an
entity is related if:
o The entity and the reporting entity are members of the same group
(e.g. parents, subsidiaries, fellow subsidiaries) think about it
o Organisations significantly influenced by, or that significantly
influence the entity (associates)
o Individuals (e.g. key management personnel KMP and their
close family members


RPTs and RP relationships
RPTs may be used to help minimise tax by shifting profits (transfer pricing).
Possibilities:
- over-pricing: a loss making entity within a group may overcharge a profit
making entity within a group in order to spread profits
- under-pricing: for example, a company has a parcel of land in Bankstown
which is excess to the companys needs. The CEO arranges to sell it to her
husband (a related party) for $500,000. It has a market value of
$2,000,000.
RP relationships:
- Economic dependence: affairs so closely linked that failure of one entity
causes failure of related parties:
o E.g. HIH (Australia); Enron (USA)
o At extreme, RP relationships and transactions can involve
corruption and/or fraud. RP disclosures may therefore have a
behavioural impact on management
Corporate scandals were the driving force for RP disclosure requirements

The rationale for disclosure as described by AASB 124 para 5-8
A related party relationship could have an effect on the profit or loss and
financial position of an entity [consider the sale of land example]
Related parties may enter into transactions that unrelated parties would not. For
example, related parties may arrange a sale on terms which would not be offered
to an unrelated customer
Chris Nobes:
- enables readers to assume that transactions were otherwise at market
price
- confirms his perspective despite the definition of related party included
subsidiaries etc, the goal is not to require disclosure of eliminated intra-
group transactions

What are we required to do under AASB 124?
What is a related party transaction?
- AASB 124 para 9: a transfer of resources, services or obligations between
related parties, regardless of whether a price is charged
What are RPDs (para 13-24)?
- parent/subsidiary relationship must be disclosed even if no transactions
have taken place between them (AASB 124 para 13)
- If there have been RP transaction disclosure (para 18)
o The amount of the transactions;
o The amount of outstanding balances including terms and
conditions, whether they are secured, and the nature of the
consideration to be provided in settlement and details of any
guarantees given or received

RPD: KMP compensation
AASB 124 (17) also requires us to disclose the remuneration of all senior
management KMP
AASB 124 Aus29.4 must disclose compensation in total and for each of the
following categories short term employee benefits, post employment benefits,
termination payments, share based payments
Why disclose? A hot topic!
- Do KMP compensation plans align the interests of KMP or with those of
shareholders and other stakeholders?
- Is compensation adequately linked to performance?
- Are they getting paid too much?
- One of many examples of concern Goldman Sachs bonuses during GFC
Corporations Act 2001 SECT 300A
Annual directors report specific information to be provided by listed
companies
(1) The directors report for a financial year for a company must also include
(in a separate and clearly identified section of the report):
a. Discussion of:
i. Board policy for determining, or in relation to, the nature
and amount (or value, as appropriate) remuneration of the
key management personnel for the company; and
ii. If consolidated financial statements are required board
policy in relation to the nature and amount (or value, as
appropriate) of remuneration of the key personnel for the
consolidated entity and
b. Discussion of the relationship between such policy and the
companys performance; and
RPD: materiality
Transactions with KMP and their CFM apart from KMP compensation
AASB 124 para Aus 1.8 & 1.9: the materiality provisions of AASB 1031
apply to related party transactions but not to KMP compensation (paras
Aus 29.1 to 29.9.3). Never the less, AASB 1031 (materiality) says that we
may need to treat all RPT as material (AASB 1031 para 12 (b))
In other words, ALL related party transactions are material (thus
disclosable)
Why is it important to disclose immaterial RPTs?

Qantas critical reflections
is that it?
My concerns:
o Are we to take it that KMP and their related parties equates to the
persons or close members of that persons family required by
AASB 124?
o Why doesnt Qantas disclose the amounts of air travel
transactions? Why does air travel apparently warrant less (no)
detailed disclosure relative to other transactions?
o Are there any outstanding balances on air travel transactions or
any provisions for doubtful debts?
o The disclosure of transactions and balances with associates and
jointly controlled entities is aggregated, however this seems to be
acceptable in accordance with AASB 114.
Limitations of RPD
There could be vast numbers of transactions with subsidiaries, parents,
associates etc, every year
- close family member test is weak: what about distant family members
and friends and other?
- Buried at the back of the notes to the accounts?
- Definitely has had some success in promoting a cultural change in the
business community in Australia compare to the crisis in banks in
Afghanistan in 2010 with money disappearing into waterfront homes in
Dubai etc.

Related party and segment summary and conclusions
The requirement to disclose detailed relating to related parties may have
a number of benefits including potentially modifying behaviour. It is
pleasing to note, for example, that note 32 to the Qantas Ltd accounts is
slim.
Both AASB 124 and AASB 8 make some effort to provide detail to support
aggregated group performance and position. They do this in a targeted
manner focusing on key risks but provide limited focus on the results of
individual legal entities in the group.
Both AASB 124 and AASB 8 are subjective and so are open to
interpretations and potentially meaningless disclosures
And we continue to see evidence of corporations having an innate fear of
disclosure
Additional
Operating Segments
The core principle of AASB Operating Segments is for a reporting entity to
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.

The alternative bases that could be used for segment reporting could include:
- the type or class of customer serviced (e.g. retail versus trade buyers);
- nature of product or service;
- nature of the production processes
- the methods used to distribute products or services;
- industry membership or classification (e.g. banking, insurance or public
utilities);
- geographical location;
- the internal management and reporting structure

As it is possible that some diversified entities may be comprised of a large
number of relatively small segments, AASB 8 Operating Segments contains a
specific requirement that the external revenues attributable to reportable
segments must comprise at least 75% of the entitys total revenues. If the
segment disclosures do not achieve this result, additional segments must be re-
designated as reportable segments, until the 75% test is met.
This test serves as an override to the other tests to ensure that relevant
information is conveyed in the segment note disclosures.