The application of International Financial Reporting Standard 8 Operating Segments: evidence from UK companies
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On 30 November 2006, the International Accounting Standard Board (IASB) released International Financial Reporting Standard (IFRS) 8 Operating Segments which replaced the revised International Accounting Standard (IAS) 14 Segmental reporting. This study consists of four main projects covering the empirical analysis of the non-financial FTSE 350 constituents’ first segmental disclosures under IFRS 8. The new standard is a result of the joint short term project between the IASB and the Financial Accounting Standards Board (FASB) and it is almost identical to its US counterpart. The first part of this study analyses the level of compliance (measured by compliance indices) with the requirements of IFRS 8 and examines the factors that might provide some explanation of the variances in the compliance levels of the companies. The results suggest that there is substantial non-compliance with the entity-wide disclosure requirements of IFRS 8. There is evidence that the companies are withholding sensitive information (such as reliance on major customers; non-current assets and external revenue attributed to the entity’s country of domicile and material foreign countries) which provides support for the proprietary cost theory. The results also indicate that the extent of compliance varies significantly. The evidences suggest that the identity of the auditor is one of the most important company characteristics in explaining the overall level of compliance with the segmental reporting requirements of IFRS 8. Thus, the audit quality provided by the BIG 4 audit companies seems to be different. Additionally, the findings reveal that the overall level of compliance and the level of compliance with the entity-wide requirements of the standard is significantly greater for companies organised around different products and services (business reportable segments) or a combination of different products, services and geographical areas (mixed reportable segments) compared to companies organised around different geographic areas (geographic reportable segments). It raises the question whether the companies use their organisational structure to conceal / reveal information. The relatively high level of non-compliance with the entity-wide requirements of the standard and the considerable variance between the levels of compliance of the individual companies questions the success of the convergence of the accounting standards and the quality and the comparability of the financial statements. It is no doubt that geographic disclosures provide useful information on assessing internationally diversified companies’ risks and prospects and on making economic decisions. The second part of this study analyses the impact of IFRS 8 on the quality of the geographic disclosures of the sample companies and tries to provide some explanation for better understanding the diversity of the preparers’ geographic disclosure practice and their possible incentives to conceal / reveal geographic information. The findings suggest that the introduction of IFRS 8 has both positive and negative impacts on the geographic disclosure quality of the companies. The results reinforce previous research findings and indicate that the companies’ geographic disclosure quality cannot be described by only one quality measure. Considerable variation was found in the companies’ geographic disclosure quality. However, none of the studied company characteristics had significant effect on all of the quality measures. Additionally, the research results seem to indicate that it is not in the interest of a relatively high percentage of the sample companies to change their geographic disclosure practice. The companies stick with their disclosure practice even under the new standard. Geographic information disaggregated to country-level results in greater accountability and transparency and provides financial information that is more useful and relevant for financial statement users than information provided for geographic regions. However, IFRS 8 only requires the separate disclosure of individually material countries and it does not provide guidance on how to set the materiality level. The third part of the study provides some insight into (1) how the companies apply the materiality concept in defining their individually material countries and (2) how different company characteristics affect the companies’ materiality decisions. The quantitative materiality threshold applied by the sample companies (estimated by the method developed by Doupnik and Seese, 2001) varies considerably which indicates that the companies do not follow a general quantitative benchmark. However, with the exception of early adoption none of the studied company characteristics had significant effect on the materiality threshold applied by the companies. The results suggest that there could be both quantitative and qualitative factors, not studied in this research that might be more important in the preparers’ materiality decisions. However, only the preparers know what is behind their materiality decision. Only a few companies disclosed information about the quantitative materiality threshold applied and none of them disclosed information about the qualitative factors considered in assessing the materiality of an individual country. The empirical findings provide evidence that the companies use both the flexibility provided by IFRS 8 and the shield of the materiality concept when they make materiality decisions about their individually material, therefore reportable countries. Greater transparency and detail about the companies’ materiality decision would reduce the uncertainty and could enhance the understandability of the companies’ segmental notes. The IASB has recently announced plans to consider a project on materiality (IASB, 2013a). The findings of this study could present relevant information to the IASB’s work on providing guidance on the application of the materiality concept. In the last decade there have been calls from civil societies, regulatory bodies and international economic organisations to require multinational companies (MNCs) to disclose information about their activities in those countries where they have operation. The fourth part of the study provides a summary of the impact of the introduction of IFRS 8 on the sample UK listed companies’ country-level disclosures and critically evaluates whether the existing geographic disclosure requirements through IFRS 8 provide sufficient financial information and transparency for the different financial statement users. The results indicate that (1) the fact that IFRS 8 only requires the disclosure of the revenue and non-current assets for the country of domicile and for the material foreign countries, (2) the way the MNCs apply the materiality concept to define countries that need to be individually disclosed and (3) the companies preference to keep geographic information at minimum level result in a relatively poor level of audited country-level information even among the largest listed companies. Therefore, what is disclosed in the companies’ audited financial statements is very far from the idea of full country-by-country reporting (CBCR). The IASB decided not to undertake proactive work in this area and preparers argue that enough information and transparency is provided under the requirements of IFRS 8. However, the findings of this study and the fact that legislative bodies in the US and in the EU had to bypass the IASB and issue CBCR related new regulations indicate that the country-level requirements of IFRS 8 and the country-level information provided by the companies in their segmental notes are not sufficient and transparent enough. To ensure the same reporting requirement for entities worldwide and to increase transparency and the availability of important geographic financial information, to enhance consistency and to help the comparison CBCR should be considered by the IASB and addressed in international accounting standard(s).