Business

Friday April 10, 2009

Boost to transparency


New segment reporting will make groups diligently assess each business unit

A NEW standard – FRS 8, Operating Segments – has been issued by the Malaysian Accounting Standards Board (MASB) to replace the current FRS 114, Segment Reporting. It will be effective for financial periods beginning on or after July 1, 2009.

Hence, listed companies having annual financial periods ending on June 30, 2010 will be the first to apply this standard in their quarterly interim report for the period ending Sept 30, 2009. However, many companies may not be aware of its implications.

FRS 8 and FRS 114 are standards that require listed companies to analyse their performance based on segments.

FRS 114 requires a company to analyse the performance of a group based on related products and services, and on geographical basis. FRS 8, however, uses a management approach, which originated from US Generally Accepted Accounting Principles (GAAP).

The “management approach” in FRS 8 requires companies to analyse their results using the same analyses that are given internally to their chief executive officers, executive committees or directors.

FRS 8 is expected to offer an opportunity for companies to improve their financial reporting by allowing users of financial statements to review their operations from the same perspective as management.

No complicated systems

This standard does not require a company to implement sophisticated systems or processes to capture information. It only requires a company to disclose the internal information based on its existing management reporting system.

As such, one could expect that FRS 8 will enable a company to provide timely segment information for external reporting with relatively low incremental costs.

However, this new approach may be unfamiliar to many companies and may require management to re-consider its internal reporting structure when applying FRS 8.

The internal reporting structure will be the key driver in determining segment reporting in the future, which in turn, could indirectly reflect the robustness of a company’s management structure and style.

For example, if the analysis provided in the financial statements is limited and if competitors are giving better information, it may convey a negative impression that management is not using the best approach to run the company. This may even adversely impact the company’s share price.

Therefore, companies with weak internal reporting structures should start doing some housekeeping work as internal management reports will be going public.

The “management approach” also means the financial information reported shall be the measure reported to the CEOs, executive committees or directors.

Hence, the actual segment profit or loss reported for management purpose will also be reported in the financial statements available to the public and they do not need to agree with the reported profit or loss in the income statement.

For example, where the directors use the cash receipt basis to monitor the performance of the entity’s segments, the same performance will be disclosed in the financial statements for the purpose of segment reporting; with a reconciliation to the actual numbers reported in the income statement that comply with the FRSs.

Management may be taken aback and be concerned that this approach may disclose information deemed to be commercially sensitive, to the extent of possible competitive damage or erosion of shareholder value.

However, the International Accounting Standards Board believes that companies are unlikely to suffer competitive harm from the required disclosures since most competitors would have sources of detailed information about a company other than its financial statements.

Developing good strategy

Based on this argument, the standard does not allow any exemptions. It is therefore important to accord the appropriate attention to the application of FRS 8 and develop a good strategy.

Management will need to have a strong understanding of the requirements of the standard and use the knowledge to balance the reporting so that it does not reveal too much valuable information, while projecting a positive view of management structure and style.

The format chosen should however continue to facilitate the provision of the appropriate information to decision-makers in a company. One can expect that external auditors will be comparing the format reported in the financial statements with the internal management report.

The standard also requires comparative financial information to be presented unless the necessary information is not available and the cost to develop is excessive.

FRS 8 also requires a disclosure of revenues from customers attributed to an individual foreign country where it is material.

Such analysis may not be available at the moment and may be sensitive to some companies such as those with material trading with sanctioned countries.

In summary, the standard requests that segment information be provided based on the internal reporting format.

This approach does not just promote transparency; it may also put pressure on management to ensure that a good internal reporting structure is established and to diligently assess each business unit within the entity.

To this end, management must carefully examine the internal reporting structure and consider whether it can ultimately withstand public scrutiny.

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