CHAPTER 13: OPERATING SEGMENT

Segment Reporting – Core Principle

The core principle of segment reporting is as follows:

An entity shall disclose information to enable users of financial statements to evaluate the nature and
financial effects of the business activities in which it engages and the economic environment in which it
operates.

Operating Segment

An operating segment is a component of an entity:

a. That engages in business activities from which it may earn revenue and incur expenses,
including revenue and expenses relating to transactions with other components of the same
entity.
b. Whose operating results are regularly reviewed by the entity’s chief operating decision maker to
make decisions about resources to be allocated to the segment and assess its performance.
c. And for which discrete financial information is available.

Identifying operating segments

Reportable segments

An entity shall report information about an operating segment that meets any of the following
quantitative thresholds:

1. The segment revenue, including both sales to external customers and intersegment sales or
transfers, is 10% or more of the combined revenue, internal and external, of all operating
segments.
2. The absolute amount of profit or loss of the segment is 10% or more of the greater in absolute
amount of:
a. Combined profit of all operating segments that reported a profit.
b. Combined loss of all operating segments that reported a loss.
3. The assets of the segment are 10% or more of the combined assets of all operating segments.

Operating segments that do not meet any of the quantitative thresholds may be considered reportable
and separately disclosed on a voluntary basis if management believes that information about the
segment would be useful to the users of the financial statements.

Illustration

Revenue, profit or loss, and assets for each operating segment areas follows:

Revenue Profit (Loss) Assets

Segment A 16,000,000 1,700,000 25,000,000
Segment B 13,000,000 500,000 11,000,000
Segment C 6,000,000 (1,000,000) 3,000,000
Segment D 3,000,000 200,000 2,000,000
Segment E 2,000,000 (100,000) 4,000,000
 40,000,000 1,300,000 45,000,000

Based on revenue, A, B and C are reportable segments because revenue associated with each of these
segments is at least P4,000,000 which is 10% of the total revenue of P40,000,000.

D and E are not reportable segments because revenue of such segments is less than 10% of the total
revenue.

Based on segment assets, A and B are reportable segments because assets of such segments are at least
P4,500,000 which is 10% of the total segment assets of P45,000,000.

C, D and E are not reportable segments because their assets are less than 10% of the total segment
assets.

Applying the criterion of 10% of profit or loss is somewhat complicated because some segments have
profit and others have losses.

The profit must be combined and the losses must be combined to determine which is greater between
the two.

Profit Loss
A 1,700,000
B 500,000
C 1,000,000
D 200,000
E _ 100,000

2,400,000 1,100,000

Because the total profit figure is greater than the total loss figure, P2,400,000 is the basis for identifying
reportable segment.

Any segment with profit or loss of P240,000 or greater (10% of P2,400,000) qualifies as reportable
segment. Therefore, A, B and C are identified as reportable segment under the profit or loss criterion.

In conclusion, A, B and C are identified as reportable segments. D and E are not reportable because they
do not meet any one of the 10% quantitative thresholds for identification as reportable segments.

Thus, D and E may be combined for reporting purposes. But A, B and C, being reportable segments, shall
be disclosed separately.

Overall size test – 75% threshold

If the total external revenue of reportable operating segments constitutes less than 75% of the entity
external revenue, additional operating segments shall be identified as reportable segments even if they
do not meet the 10% quantitative thresholds until at least 75% of the entity’s external revenue is
included in reportable segments.
Aggregation of segments

Two or more operating segments may be aggregated into a “single operating segment” if the segments
have similar economic characteristics and the segments share a majority of the following five
aggregation criteria:

a. Nature of product or service

b. Nature of production process
c. Type or class of customers
d. Marketing method or the method used to distribute the product
e. The nature of the regulatory environment, for example, banking, insurance or public utility

Illustration

An entity has no intersegment sales and has the following operating segments with their corresponding
revenue:

Segment Revenue Percentage

1 2,400,000 30%
2 1,600,000 20
3 1,200,000 15
4 720,000 9
5 640,000 8
6 560,000 7
7 480,000 6
8 400,000 5___

8,000,000 100%

Based on the revenue criterion, the reportable segments are segments 1, 2 and 3. The remaining
segments are not reportable.

Assume that the remaining segments did not also satisfy the other criteria of “profit or loss” and “total
assets”.

The total external revenue of the reportable segments is as follows:

Revenue Percentage
Segment 1 2,400,000 30%
2 1,600,000 20%
3 1,200,000 15%

5,200,000 65%

Observe that the total percentage of the reportable segments is only 65%.

In this case, additional operating segments shall be identified even if they do not meet any of the 10%
quantitative thresholds.
Aggregation

Two or more operating segments may be aggregated into “one reportable segment” to achieve the
“75% of the entity external revenue” threshold.

However, the operating segments to be aggregated must have similar economic characteristics and
share a majority of the five aggregation criteria

Assume that Segments 7 and 8 have similar products, similar production process, similar marketing
method and are not operating under regulated environment.

Accordingly, Segments 7 and 8 can be aggregated as “one reportable segment” to achieve the 75%
threshold.

Segment 1 30%
Segment 2 20%
Segment 3 15%
Segments 7 and 8 (6% + 5%) 11%

76%

Thus, the remaining segments 4, 5 and 6 shall be considered not reportable and lumped in the “other
segments” category.
CHAPTER 13: OPERATING SEGMENT

PROBLEMS

Problem 1

Correy Company and its divisions are engaged solely in manufacturing operations.

The following data pertain to the industries in which operations were conducted for the current year:

Industry Revenue Profit Assets

A 10,000,000 1,750,000 20,000,000

B 8,000,000 1,400,000 17,500,000
C 6,000,000 1,200,000 12,500,000
D 3,000,000 550,000 7,500,000
E 4,250,000 675,000 7,000,000
F 1,500,000 225,000 3,000,000

32,750,000 5,800,000 67,500,000

How many reportable segments does Correy have?

a. Three b. Four c. Five d. Six

Solution: Answer C

Under PFRS 8, an entity shall disclose information about an operating segment that meets any of the
following quantitative thresholds:

1. The segment revenue, including both sales to external customers and intersegment sales or
transfers, is 10% or more of the combined revenue, internal and external, of all operating
segments.
2. The segment profit or loss is 10% or more of the greater of the following in absolute amount:
a. The combined profit of all operating segments with profit.
b. The combined loss of all operating segments with loss.
3. The assets of the segment are 10% or more of the combined assets of all operating segments.

Accordingly, A, B, C, D and E are reportable segments because their revenue or profit or asset is at least
10% of the combined amount.

Problem 2

Macbeth Company, an entity listed on a recognized stock exchange, reports operating results from its
North American division to the chief operating decision maker.
The entity revealed the following segment information for the current year:

Revenue 3,800,000
Profit 1,200,000
Assets 1,800,000
Number of employees 2,500

The results for all of the operating segments in total are:

Revenue 40,000,000
Profit 10,000,000
Assets 20,000,000
Number of employees 25,000

Which piece of information determines that the North American division is a reportable segment?

a. Revenue b. Profit c. Assets d. Number of employees

Solution: Answer B

Profit threshold (1,200,000 / 10,000,000) 12%

The revenue of the North American segment of P3,800,000 is less than 10% of the total revenue of
P40,000,000 of all operating segments.

The assets of the North American segment of P1,800,000 are less than 10% of the total assets of
P20,000,000 of all operating segments.

The number of employees is not a criterion in determining reportable segment.

Problem 3

In the income statement for the current year, Grum Company reported revenue P50,000,000, excluding
intersegment sales P10,000,000, expenses P47,000,000 and net income P3,000,000.

Expenses included payroll costs of P15,000,000.

The combined identifiable assets of all operating segments at year-end totaled P40,000,000.

1. The entity should disclose major customer date if sales to any single customer amount to at least

a. 5,000,000 b. 4,000,000 c. 6,000,000 d. 4,700,000

2. External revenue of reportable operating segments must be what amount?

a. 22,500,000 b. 30,000,000 c. 33,750,000 d. 37,500,000

Solution:

Question 1: Answer A

10% x 50,000,0000 5,000,000

PFRS 8, paragraph 34, provides that a major customer disclosure is required if an entity derives 10% or
more of its external revenue from a single customer or group of entities under common control.

Question 2: Answer D

75% x 50,000,000 37,500,000

Under PFRS 8, paragraph 15, the total external revenue attributable to reportable operating segments
must be at least 75% of the total entity external revenue.

Problem 4

Graf Company discloses supplemental operating segment information. The following information is
available for the current year:

Segment Sales Traceable expenses

X 5,000,000 3,000,000
Y 4,000,000 2,500,000
Z 3,000,000 1,500,000

12,000,000 7,000,000

Additional expenses are as follows:

Indirect expenses 1,800,000

General corporate expenses 1,200,000
Interest expense 600,000
Income tax expense 400,000

The interest expense and income tax expense are regularly reviewed by the chief operating decision
maker as a measure of profit or loss.

Appropriate common expenses are allocated to segments based on the ratio of a segment’s sales to
total sales.

What is Segment Z’s profit for the current year?

a. 900,000 b. 950,000 c. 800,000 d. 500,000

Solution: Answer C

Sales – Segment Z 3,000,000

Expenses:
Traceable expenses 1,500,000
Indirect expenses (3/12 x 1,800,000) 450,000
Interest expense (3/12 x 600,000) 150,000
Income tax (3/12 x 400,000) 100,000 2,200,000

Segment profit 800,000

General corporate expenses are not allocated to operating segments as a measure of profit or loss.

Problem 5

Revlon Company had no intersegment sales and provided the following data for the current year:

Segment Revenue Profit (Loss) Assets

1 620,000 200,000 400,000

2 100,000 20,000 80,000
3 340,000 70,000 300,000
4 190,000 (30,000) 140,000
5 180,000 (25,000) 180,000
6 70,000 10,000 120,000
7 120,000 (20,000) 140,000
Others 380,000 (25,000) 140,000

 The “others” category includes five operating segments, none of which has revenue or assets
greater than P80,000 and none with an operating profit.
 Operating Segments 1 and 2 produce very similar products and use very similar production
process, but serve different customer types and use quite different product distribution system.
These differences are due in part to the fact that Segment 2 operates in a regulated
environment while Segment 1 does not.
 Operating Segments 6 and 7 have very similar products, production processes, product
distribution systems, but are organized as separate divisions since they serve substantially
different types of customers.
Neither Segments 6 and 7 operate in a regulated environment.

What are the reportable segments for the current year?

a. Segments 1, 3, 4 and 5 c. Segments 1, 3, 4, 5 and 7

b. Segment 1, 2, 3, 4 and 5 d. Segments 1, 3, 4, 5 and Segment 6 and 7 combined as one segment

Solution: Answer D

Segment Revenue Profit (Loss) Assets

1 620,000 200,000 400,000

2 100,000 20,000 80,000
3 340,000 70,000 300,000
4 190,000 (30,000) 140,000
5 180,000 (25,000) 180,000
6 70,000 10,000 120,000
7 120,000 (20,000) 140,000
Others 380,000 (25,000) 140,000

Total 2,000,000 200,000 1,500,000

1. The information above shows that any operating segment with revenue equal to or greater than
P200,000 is a reportable segment (Segment 1 and 3).

Any segment with assets equal to or greater than P150,000 is a reportable segment (Segments
1, 3 and 5)

The total profit for all segments with profit totals P300,000. As a result, any segment with profit
or loss equal to or greater than an absolute amount of P300,000 is a reportable segment
(Segments 1, 3 and 4).

Thus, Segments 1, 3, 4 and 5 are reportable segments.

2. The revenue of the reportable segments is as follows:

Segment 1 620,000
3 340,000
4 190,000
5 180,000

Total revenue 1,330,000

Percentage (1,330,000 / 2,000,000) 66.5%

If the total external revenue attributable to reportable segments constitutes less than 75% of
the entity external revenue, additional segments shall be identified even if they do not meet the
10% quantitative thresholds until at least 75% of the entity external revenue is included in
reportable segments.

Moreover, reportable segments that are below the 10% threshold can be aggregated as one
segment of they have similar economic characteristics and share a majority of the five
aggregation criteria as follows:

a. Nature of product
b. Nature of production process
c. Class of customer
d. Method of distributing product
e. Regulated environment

Since Segments 6 and 7 are similar in four of the five criteria, these semgnets can be aggregated
as one reportable segment.

Segment 6 Segment 7 Total

Revenue 70,000 120,000 190,000

Profit (Loss) 10,000 (20,000) (10,000)
Segment assets 120,000 140,000 260,000

With Segments 6 and 7 considered as one reportable segment, the total segment revenue
increases to P1,520,000 or 76% of the total. The requirement has been met.
 Revenue of reportable segments before aggregation 1,330,000
Revenue of additional reportable segments 190,000

Total 1,520,000

Percentage (1,520,000 / 2,000,000) 76%

3. In conclusion, Segments 1, 3, 4, 5 and Segments 6 and 7 (combined) shall be considered

reportable segments.