Segment Reporting: Concept, Benefits and Limitations

In this article we will discuss about Segment Reporting:- 1. Concept of Segment Reporting 2. Benefits of Segment Reporting 3. Limitations 4. Difficulties.

Concept of Segment Reporting:

The basic goal of a country’s economy is to maximise the economic and social welfare of its citizens through an efficient allocation of resources. In developing economies, chartered by inadequate resources, capital is the scarcest and most important productive factor. To obtain their capital at a lower cost, the business enterprises and companies in particular, go to the capital market.


Since capital owners and investors, like the business enterprises, also attempt to maximise their own economic returns, they require information in order to make sound economic decisions. The quality of information available to them would, in turn, lead to a more efficient allocation of resources in a country’s economy.

In the absence of meaningful information, capital owners, investors, creditors and others are likely to make investment decisions based on tips, hunches, guess work and unreliable news leading to an inefficient allocation of resources in the economy.

Sorter and Gams observe:

“Society looks to corporations for assistance in the efficient allocation of resources and expects the corporations to assume the responsibility of providing information that furthers this goal.”

A remarkable feature of modern business in India as well as abroad has been the growth of diversified enterprises that carry on activities in two or more lines of business. This widespread movement towards diversification has led to a need for information about the various segments of an enterprise in addition to consolidated financial statements about its overall performance.

This need arises because the broadening of an enterprise’s activities into different industries or geographic areas complicates the analysis of conditions, trends and ratios and therefore of the ability to predict. The various industry segments or geographic areas of operations of an enterprise may have different rates of profitability, degrees and types of risk, and opportunities for growth.


There may be differences in the rates of return on the investment commitment in the various industry segments or geographic areas and in their future capital demands. The investors cannot successfully evaluate a diversified enterprise without information about its various segments; consolidated or- total financial statements usually combine accounts of all the segments and information about each segment may be indistinct.

A diversified company (sometimes loosely used as conglomerate company) has been defined by Mautz as:

“…A company which either is so managerially decentralised, so lacks operational integration, or has such diversified markets that it may experience rates of profitability, degrees of risk, and opportunities for growth which vary within the company to such an extent that an investor requires information about these variations in order to make informed decisions.”

Subsequently, Mautzs found that the (above) definition of a diversified company required modification in two respects, if it is to be adopted for financial reporting problems of diversified companies.


Firstly, common usage requires that the class of companies described in the definition is more appropriately referred to as diversified companies than as conglomerate companies.

Secondly, for all practical purposes, the type of diversification of significance for financial reporting purposes can be viewed as industry diversification. There may be other types of diversification also such as internal diversification resulting from either management decentralisation or non-integrated operations, external or market diversification because of differences in customers or products or because of geographical distribution of its assets.

Conceptually, these are all possible but, practically, with the exception of industry diversification, they are extremely difficult to identify. Thus, diversified enterprises are engaged in diversified operations, i.e., activity or operations in different industries and with foreign operations and sales where those activities and operations are significant in terms of sales revenue, profit or losses generated or assets employed.

It is also true that segmentation along industry and geographical lines is likely to indicate most of the distinguishable components of the diversified enterprise which are subject to different profitability, different risks and different growth prospects.

Benefits of Segment Reporting:

Information reported in a business enterprise’s financial statements constitutes an important input to financial statement analysis which is generally made in investment and lending decisions. Investors and lenders analyse information relating to a business enterprise to evaluate the risk and return associated with an investment or lending alternative.


Financial Accounting Standards Board of the USA states:

“The purpose of the (segment) information is to assist financial statement users in analysing and understanding the enterprise’s financial statements by permitting better assessment of the enterprise’s past performance and future prospects.”

According to AS-17 ‘Segment Reporting”:

Segment information helps users of financial statements:

(a) Better understand the performance of the enterprise;

(b) Better assess the risks and returns of the enterprise; and

(c) Make more informed judgments about the enterprise as a whole.

Information about the different types of products and services an enterprise produces and the different geographical areas in which it operates would be useful in the following respects:

1. Allocation of Resources:

Segment information, if disclosed to parties outside the enterprise, would play an important role in improving the allocation of scarce resources in an economy. Non-availability of information creates uncertainty in the investment market and thereby makes the investment market inefficient.

The disclosure of information removes the imperfections in the investment market and causes the market to function properly. Also, the disclosure of segment information may influence greatly management performance and encourages them to work in the interest of society and investors. It helps in checking corporate abuses related to such matters as fraud, unfair pricing policy and trade practices.

Beaver Observes:

“Financial information can also affect how investment is allocated among firms. Disclosure may alter investors beliefs about the relative rewards and risks associated with particular securities. Consider the recent analyses of the effects of inflation on corporate profits. It has been stated that failure to disclose the effects of inflation, among other things, may be contributing to a misallocation of resources toward industries or groups of firms showing illusory profits. To the extent that disclosure does alter investor perceptions of relative rewards and risks, investors will shift toward more desirable investment opportunities. In general, this shift may be reflected in the manner in which new capital is allocated among firms.” Thus, financial disclosure for business segments may result into more efficient allocation of resources.

2. Investment and Credit Decisions:

It is widely recognised by authors in accounting and finance, accountants and accounting bodies that segment information has great usefulness in investment and credit decisions.

It is argued that segment information enables the financial statement users to better analyse the uncertainties surrounding the timing and amount of expected cash flows—and therefore, the risks—related to an investment or a loan to an enterprise that operates in different industries and markets.

Since the progress and prospects of diversified enterprise are composites of the progress and prospects of its several parts, financial statement users regard financial information on a less than total enterprise basis as also important.

A large US investment research firm, Duff and Phelps Inc., has also commented on the importance of segment data for investment decisions in the following manner:

“In complex diversified enterprises, consolidated financial statements have limited value for making earnings projections because they cannot be related to the several business-economic environments in which the company operates. Each line of business is affected not only by general economic conditions but by special industry factors such as volume, price and raw material costs trends. Each segment is likely to have different markets, profit margins, rates of growth, returns on investment and business cycle sensitivity, so each must be studied separately to develop a projection of segment earnings. These, in turn, are combined into a consolidated projection. The same considerations apply to foreign operations by important geographic areas, even though the product line is not diversified. Segment financial data, thus, are essential to the analytical process.”

In credit decisions, creditors like shareholders, are interested basically in profitability and cash flows of a debtor company. Profits are the source of funds for paying interest and principal of loans. In making short-term loans decisions the banker aims to forecast short-period cash flow as an indicator of a customer’s ability to meet maturing financial obligations.

A banker is interested in segment information for short-term loans to disclose areas of weakness such as unprofitable products or markets that absorb rather than produce funds for meeting debts. It should be noted, however, that bankers have power to demand more information from a client than the investors.

A number of studies have been conducted which concludes that financial statement users regard segment data as very useful in making proper economic decisions. For example, studies conducted by Kinney, Korchanek and Collins support the hypothesis that the availability of segment data offers information which enables users to better predict the future performance of the company.

Baldwin has found that security analysts are able to make more accurate earnings projections after access to segmented data and therefore concluded that segmented or line-of-business reporting would benefit users. Thus, segment information enhances investors’ ability to understand a diversified company and to make accurate and useful forecast about the profitability of segments as well as the company as a whole.

3. Equilibrium in Share Prices:

The segment disclosures would tend to adjust the prices of company shares according to information released. Horwitz and Kolodny examined the influence of segment data on company share prices. They took into account both changes in risk and changes in expected return resulting from segment profit disclosure. Their results support the no-information hypothesis.

Simonds and Collins do not agree with the Horwitz and Kolodny results and claim to find a significant reduction in risk for those firms reporting segment profit data. A more recent study by Dhaliwal, Spicer and Vickrey supports the results of Simonds and Collins in that they find a reduction in the cost of equity capital for firms disclosing segment profit data for the first time.

4. True and Fair View:

An important provision of the Companies Act in India (and abroad) is to reveal a true and fair view of the results of operation and financial position. Segment disclosures may be greatly required in terms of the true and fair criterion established in the Companies Act. This has encouraged provision for disclosure of segmented information in the legislation of certain countries of the world such as the USA and Canada.

Also, segment disclosures are advocated by international agencies like the UN and the OECD. In some countries, the accounting bodies have prepared guidelines for the disclosure of segment information in company annual reports.

For example, the Financial Accounting Standards Board of USA has issued Statement No. 14, Financial Reporting for Segments of a Business Enterprise in December 1976. An Australian study argues that an auditor may be held legally responsible in certain circumstances if he gives an unqualified report on overall financial statements which do not reveal, where they exist, significant disparities in segment results.

The above-mentioned benefits associated with segment disclosure point out that segment reporting is desirable in published annual reports of diversified companies to present true and fair results of their business activities, and to help investors in making proper investment decisions. The Financial Accounting Standards Board of the USA observes.

“Society needs information to help allocate resources efficiently but the benefit to any individual or company from that source is not measurable. Nor is the spur to efficiency that comes from making managers account to stock-holders capable of evaluation, either at the level of the enterprise or the economy. It is impossible to imagine a highly developed economy without the financial information that it now generates and—for the most part- consumes; yet it is also impossible to place value on that information.”

Limitations of Segment Reporting:

Arguments against disclosure of information about segments of a diversified company generally emphasize practical difficulties. The opponents acknowledge the importance of segment reporting for investors.

However, the critics point out two basic problems:

(i) Misunderstanding likely to be found among investors about segment information

(ii) Potential detriment to the reporting company of disclosing information about individual segments.

Some arguments advanced against segment reporting may be listed as follows:

1. Investment by investors and creditors is made in a company and not in its individual segments. Therefore investors require information for the company as a whole for making proper decisions. In a study it was found that the majority of the companies did not believe that segment information was relevant to the investors decisions.

Although, the investors invest in a company but a company is made of its different segments and segment information is very useful in making better analysis of the risk-return characteristics of the investment. Therefore, better predictions of both risk and future performance may be made from disaggregated data.

Information about the make-up of a business is also useful to an investor in seeking a desired balance in his portfolio. If such information is lacking, an investor may unknowingly maintain too large a commitment in some one field of industry or he may pass up investment opportunities because he fails to understand and evaluate them correctly in the light of his own objectives.

2. Segment information might be misleading to the investors and other external users who read it. Operating data by segments are developed for internal management users and often arbitrary judgments are made by management for developing such segment data. Although the nature and limitations of segment data are known to internal management users, external users have difficulty in understanding them and using them in investment decisions.

The limitations of segment data are inherent in the nature of accounting as a means of communicating information about a business segment. This is true in the communication of information at the company level also. Accounting is handicapped in disclosing all the information that is necessary in investment decisions.

For instance, accounting cannot directly provide information about the physical condition of a company’s plants or the competence of company managements. Similarly, a segment whose products are still in the developing stage may compare unfavourably with another segment whose products are well-developed.

The products in developing stage may be as essential to the company as the developed products and sometimes developing products need to be pushed at the cost of more developed (profitable) products.

However, accounting is unable to communicate such information clearly, consequently, investors and creditors, being not aware of limitations of accounting, may arrive at wrong conclusions in investment decision-making. However, it is impracticable to cater for careless users of financial statements, they could misuse or ignore any information, aggregated or disaggregated, that is presented.

The Financial Accounting Standards Board of USA has adopted the following test regarding users:

“The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence.”

Users with this or a higher level competence should be able to understand the uses and limitations of segment data provided the data presented are clear and understandable. Besides, this criticism underestimates the ability of capital market participants correctly and un-biasedly to interpret the information made available to them.

It is true that it is difficult (rather impossible) to know precisely the capacity of individual users to analyse information. Nonetheless, when considered as a group, there is substantial empirical evidence to support the hypothesis that they (users) are very sophisticated in their ability to analyse and interpret information.

3. Segment data are also criticised on the ground that they cannot be prepared with sufficient reliability and it is beyond the scope of external financial reporting to provide such analytical or interpretive data.

However, the term ‘reliability’ does not indicate any precise or clear concept in accounting, and it may have a variety of meanings. For example it may encompass ‘representational faithfulness’ and ‘verifiability’ as recognised by the Financial Accounting Standards Board, USA.

“The reliability of a measure rests on the faithfulness with which it represents what it purports to represent, coupled with an assurance for the user, which comes through verification, that it has that representational quality. Information may be unreliable because it has one or both kinds of bias. The measurement method may be biased, so that the resulting measurement fails to represent what it purports to represent. Alternatively, or additionally the measurer through lack of skill or lack of integrity, or both, may misapply the measurement method chose. In other words, there may be bias, not necessarily intended on the part of the measurer.”

There are definite reliability problems with segment data due to some difficulties such as defining the segment, allocating common costs, and pricing intersegment transfers. However, the question of reliability is not applicable to segment reporting alone; it can be applied to the overall financial reporting framework.

Also, it is not reliability in the absolute sense that is important. The main criterion is whether users are, in totality, better off or worse off if segment information is developed with possible accuracy and supplied to them.

The Accounting Principles Board states:

“Measurements cannot be completely free from subjective opinions and judgements. The process of measuring and presenting information must use human agents and human reasoning and therefore is not founded solely on an ‘objective reality’. Nevertheless, the usefulness of information is enhanced if it is verifiable, that is, if the attribute or attributes selected for measurement and the measurement methods used provide results that can be corroborated by independent measurers.”

Furthermore, segment information cannot be said to be analytical or interpretative and it can be classified purely as accounting information. It is argued that segment information is a rearrangement, i.e., a disaggregation of information included in an enterprise’s aggregated financial statements, as is the information required in the statement of changes in financial position, a rearrangement of information reported in or under-lying the balance-sheet and income statement. Therefore, the information required in a segment reporting proposal does not go beyond or enlarge the boundaries of accounting.

4. A reporting company has to incur costs in developing, preparing and providing segment information to external users which may be too high. Also, a company has to incur the competitive costs, i.e., costs due to harm done to the reporting company and its shareholders through a weakening of the company’s commercial position.

Horwitz and Kolodny advise:

“…It is important that estimates be gathered on the costs of that disclosure; for evidence that security prices are affected by the formal release of segment data does not necessarily imply that they have social value. To reach this conclusion, we require a method of converting affected security price change into a metric that can be used for comparison with the cost of preparing such data. To demonstrate that potential benefits result from additional disclosure is no longer adequate without consideration of related costs. This task remains unresolved at present.”

5. Presenting the results of segment operations to external users could lead to competitive damage. Confidential information would be revealed to competitors about profitable or unprofitable products, plans for new products or entries into new markets, apparent weaknesses which might induce competitors to increase their own efforts to take advantage of the weakness, and the existence of advantages not otherwise indicated.

Competitors may learn valuable information about profit margins and new product lines, and thus competitors may invade the company’s most lucrative market. Customers may mistakenly conclude that products are overpriced. Government authorities may erroneously decide that the company is employing unfair competitive practices. Disclosures having those results may harm the reporting company and ultimately its investors.

Consequently there may be a negative impact on corporate innovation and experimentation. The prospective returns to innovative activity may be reduced with the consequence that there is less innovation—an activity which is important to economic growth and advancement of living standards. However, there is some doubt about how individual companies would be affected by segment disclosures. In certain quarters, there is a feeling that the problem of competitive damage can be exaggerated.

The International Accounting Standards Committee observes:

“…(it) is sometimes expressed that disclosing information about segments may weaken an enterprise’s competitive position because more detailed information is made available to competitors, customers, suppliers and others. For this reason some consider it appropriate to allow the withholding of certain segment information where disclosure is deemed to be detrimental to the enterprise. Others believe that this disclosure is no more onerous to the diversified enterprise than is the disclosure of the information required of an enterprise operating in only one industry or geographical area, and that relevant information is often available from other sources. Also, analysis by segments of the aggregated financial information of a diversified enterprise is widely deemed to provide useful data that enable users to make a better assessment of the past performance and future prospects of the enterprise.”

A study done by the Institute of Chartered Accountants in England and Wales (UK) concludes:

“We accept that the disclosure may add somewhat to (or, more likely, confirm) the information that competitors and customers already have, although we believe that this difficulty is overstated. The type of information which might be disclosed is not, in our opinion, likely in most cases to be sufficiently detailed to cause commercial problems.”

Similarly Duff and Phelps state:

“We have rarely, if ever, encountered any real loss of competitive advantage as a result of segment reporting. Companies often have more useful intelligence on competitors than segment data reveal. Also, many of today’s segments were yesterday’s independent companies, operating successfully in a competitive market place and issuing, more detailed financial reports than asked for here.”

Mautz and May have found that disclosure requirements can create a competitive disadvantage to a company:

(a) If the cost of disclosure falls unequally on competitors in the same market,

(b) If the required disclosure provides competitors with information which is useful to them in formulating competitive strategy and which otherwise would not be available to them, and

(c) If innovation and risk-taking by the reporting company are discouraged.

It is also said that competitors generally already know a great deal about each other. In many cases, competitors are an excellent source for obtaining withheld and confidential operating data about business enterprises. If competitors seem to possess all the information, the owners and investors would be the only parties uninformed about data regarding the various segments in which the company is engaged.

Besides, segment information is basically meant to permit external users to make a better assessment of the past performance and future prospects of an enterprise operating in more than one industry.

From the viewpoint of total economy, loss (due to disclosure) incurred by a company would be a gain for the other company. If all diversified companies are required to disclose segment information, few among them may suffer a net loss. The benefits and costs of segment reporting are likely to be widely diffused throughout society.

Rappaport and Lerner describe some possible societal benefits:

“In short, the disclosure of information—financial or non-financial—helps make the economy more competitive because it reduces the uncertainty that surrounds investments in both new and mature business activities. When businesses engage in disparate activities with varying demand and cost characteristics, the information content of financial statement is likely to be enhanced when the results of each activity are separately reported. The business community as a whole therefore benefits from more useful information on two counts. First, business can initiate activities and expand in new directions with less risk and, therefore, at a lower cost than might otherwise be possible. Second, the rate-of-return on investments will tend to be higher because fewer false starts or errors of total ignorance are likely.”

“As the economic system operates with less waste and as the economy becomes more competitive—and it should if better information flows initiate proper action—society as a whole will benefit. Marginal revenues from producing one additional unit of output will be driven nearer the level of marginal costs of producing that unit, which process is instrumental in generating favourable economic conditions.”

The debate whether segment disclosure could lead to competitive disadvantage is not over. An important question is whether any unfair costs or losses will accrue to reporting companies and shareholders or external users. This question has not been investigated empirically so far and the future researchers should find out and report the truth.

The International Accounting Standards Committee observes:

“Rates of profitability, opportunities for growth, future prospects and risks to investments may vary greatly among industry and geographical segments of an enterprise. Thus, users of financial statements need segment information to assess the prospects and risks of a diversified enterprise which may not be determinable from the aggregated data. The objective of presenting information by segments is to provide users of financial statement with information on the relative size, profit contribution, and growth trend of the different industries and different geographical areas in which a diversified enterprise operates to enable them to make more informed judgments about the enterprise as a whole.”

Difficulties in Segment Reporting:

The difficulties involved in segment reporting are, truly speaking, the problems of implementation. However, there are some difficulties of which company managements and investment community are aware and which must be resolved if segment information is to be disclosed in company annual reports.

Some problems in implementing segment reporting proposal are listed below:

(1) Basis of Segmentation:

How a diversified company should be fractionalized for reporting purposes is a problem in segment reporting. Basically there are three questions involved in this vital problem.

Firstly, the improbability of developing a single uniform system which would permit segmentation of all companies on a reasonable basis.

Secondly, development of a system which will realistically reflect the operations of the companies concerned.

Thirdly, misunderstandings that are likely to result from attempting to view parts of a total company as if they were independent units subject to independent valuation.

The greatest problem in segmenting a diversified enterprise lies in the fact that diversification may exist in different forms such as, industry, product lines, individual products, markets and geographical areas. Each type of diversification may create segments that vary significantly in terms of profitability, growth and risk.

Besides, more than one type of diversification may be found in an enterprise simultaneously. Also, terms like industry, product, location and market are not very precise. Some argue that it is difficult to evaluate a segment separate from the rest of the company.

It should be understood that the purpose of segmentation is to provide information which will help financial statement users to judge the future success of the company. Therefore segments selected should be realistic and viable from the operating point of view.

Put another way, segment(s) selected in a diversified company for financial reporting purposes should represent the company and company operations, reflect the difference within the company regarding rate of profit, degrees of risk and potential for growth.

(2) Allocation of Common Costs:

Common costs for the purpose of preparing segment reports need to be apportioned between different products (segments). In some cases, common costs are apportioned on a basis which may be classified as reasonable and reliable. For example, factory rent is a common cost which can be divided among different segments on the basis of the area occupied by them.

Similarly, the expenses pertaining to a central accounting department may be apportioned among different segments without much difficulty if details about the time devoted to the accounting matters of each segment by the company accounting department is available.

But the expenses of planning department (established at the company level) may be very difficult to apportion as no direct relation between the services provided by the planning department and the benefits accruing to different segments may be visible.

If a common cost is apportioned on a basis which does not reflect a rational relationship, the basis, being totally unjustified, would produce inaccurate and unreliable segment figures. It may be concluded that common costs have to be grouped in terms of how easily they can be apportioned among different segments.

The problem of allocating common items (common assets and liabilities) is greater for some items than for others. It is particularly great for assets, liabilities, and equity so that reporting for business segments is suggested less often for information from the balance sheet, statement of shareholders’ equity and funds statements than for information from the income statement.

Thus, some common costs can be allocated on a rational basis; some may be distributed on a basis which may even reflect whim or bias. Because of the diversity of methods employed, cross- company comparisons of similar segments are likely to be misleading, and the reliability of segment operating results varies depending on how closely the basis of allocation approximates results that would have been produced by market transactions.

A study done by the Accountants International Study Group observes:

“The problem of allocating common items has no theoretically correct solution, and its practical solutions pose a dilemma for an accountant attempting to report information for a segment of a diversified company. On one hand he can restrict segmentation only to those portions of revenue, expenses, and other items that can be directly identified with specific segments and report all other items as an undivided aggregate. Alternatively, he can segment all items using indirect bases of allocation that are frequently arbitrary. Neither approach is entirely satisfactory. The first produces segmented information that is incomplete, the second produces segmented information that is a mixture of information that varies widely in objectivity and relevance.”

(3) Pricing of Inter-Segment Transactions:

The segments in a diversified company may or may not have substantial amounts of inter-segment transactions. A diversified company having disparate segments may have very few inter-segment transactions. On the contrary, a diversified enterprise may have closely integrated segments which would surely have very substantial transactions among themselves.

Indeed, there may be segments which have no outside transactions under any circumstances. As compared with the apportionment of common costs, it is relatively easy to price inter-segment transactions. Internally, a company will price its transactions between its segments in order to hold the various segments responsible for their activities and operations.

An important secondary purpose of the pricing, however, may be to motivate employees, or actually to measure the success of the several segments as accurately as possible.

Solomons has suggested that all inter-divisional transfers be made at cost, including a proportionate share of overhead:

“The best procedure seems to be to eliminate inter-divisional sales from reports to stockholders. This is really equivalent to saying that all materials or products transferred between divisions shall be transferred at cost, including a proportionate share of overhead. The result will be to leave each division to bear the cost of goods sold to outside customers and it would report sales to outsiders and the cost thereof.”

The market price for pricing inter-segment transactions may be more useful for external users as it provides accurate revenue data based on the transactions approach and the realisation concept. Although market values result in a more accurate determination of segment profitability, they are often difficult to determine as no readily available open market transactions exist as a standard against which to measure the price used.

The use of marginal cost (variable costs) tends to understate the revenue of supplying segment. In full cost plus profit margin or negotiated price based on full cost techniques, revenue is recognised by the transferring segment before an outside sale takes place. Sometimes it leads to an inaccurate and premature measure of segment performance.

In case the full cost method is used, the profit of the transferring segment happens to be understated because the profit margin likely to be earned on the transfers is not considered. The inclusion of profit margin is possible only when market price technique is used.

No single accounting method is available which may be classified as the most appropriate. If market values are difficult to determine, full cost of the product or a negotiated price is considered an acceptable alternative. Additional research is needed with regard to determination of a suitable method of intersegment transfers. However, segment reporting should not be withheld simply because an appropriate method is not available.

(4) Comparability of Segment Data:

There is the question of comparability of the data disclosed when (1) apparently similar segments, in different firms may be identified differently; (2) the treatment of inter-segment transfers may differ, and common costs may be allocated on different bases.

Problems concerning the technical feasibility of segmental reporting may limit its current usefulness in practice, but do not necessarily undermine its potential relevance. Secondly, comparability between segments is not, in any case, an essential goal of segmental reporting.

The main aim is to promote a more informed evaluation of the performance and prospects of each firm, including the prediction of profits and cash flows, so that comparisons can be made at the firm rather than at the segmental level.

(5) Degree of Integration in Segment Activities:

A more significant argument against segmental reporting can be made where a firm is highly integrated. In the case of a vertically-integrated firm, the recognition of external markets for intermediate goods may not always be warranted.

Similarly, in the case of a horizontally-integrated firm, there may be circumstances where there is a substantial amount of interdependence between activities which are coordinated by management to an extent that the recognition of separate activities cannot be supported.

Where a firm’s operations are highly integrated and closely coordinated, then it seems unlikely that meaningful segmental reports will result. The problem is how to determine the critical point at which disaggregation no longer becomes justifiable, or segmental reports valuable.

(6) Costs of Segment Disclosure:

Further arguments against segmental reporting are concerned with the costs of disclosure. The provision of additional information will, undoubtedly, increase a firm’s operating costs in terms of the costs of collection, processing, audit and dissemination. A further potential cost is where the company’s management control system needs to be adapted to allow the relevant data to be collected.

Much will depend on the quantity and quality of data required and the nature of the company’s existing control system. It seems likely that, in many instances, management will already be gathering relevant segmental data for its own internal purposes, and it may well be that this can be readily adapted for its external users.

The level of disaggregation required seems likely to be an important cost consideration. It can be argued that there must be some limit to the number of segments disclosed and to their related information content. There is also the question of information overload to be taken into account which even in the case of sophisticated investors may eventually have dysfunctional consequences.

Another important cost argument relates to the increased competition that may result from segmental disclosures. It is argued that the disclosure of profitable segments will attract competitors, whilst loss- making segments may become the subject of take-over bids or put pressure on management to sell them off, with the purpose of improving profits in the short-term and to take on less risky projects.

A competitive disadvantage may also occur where foreign companies are not required to provide segmental reports. In addition, government scrutiny may also be encouraged, especially in the case of multinational companies with possible regulatory or tax consequences.

Against these arguments is the public interest in the form of competition as a means to a more efficient allocation of resources in the economy taken as a whole.

A key question is, of course, the extent to which competition is seen to be a desirable goal, and the extent to which regulation of disclosure is seen to be necessary to achieve it. This is likely to vary across countries according to the balance of value judgments at any point in time concerning the costs and benefits involved.

7. Management Conservatism:

Another argument is that, where there is no regulatory provision to disclose segmental reports, voluntary disclosures are likely to be perceived by managements to be beneficial only in certain instances; for example, where management believes that the company’s attractiveness to investors will be enhanced and the costs of finance reduced.

Few companies are likely to take voluntary action that may benefit their competitors or reveal weaknesses.

Further, where regulations exist but gives too much discretion to management, it tends to be largely ineffective as either there is no disclosure, or where there is, it is of questionable value owing to “conscious manipulation or inadvertent discrimination” in the identification of the segments to be reported.

In summary, there are a number of valid arguments in favour of segment reporting which, in the case of investors, are supported to some degree by empirical research findings. On the other hand, there are situations where segmental reporting may not be meaningful, where there is little stimulus for disclosures to be made, and where the costs may outweigh the benefits.

A fundamental problem concerns the evaluation of costs and benefits especially where social objectives inevitably intrude. Any decision to provide or require segmental disclosures must also involve consideration of a further set of problems, including the identification of reportable segments as well as issues of materiality, content, measurement, presentation and audit.

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