The Impact of the Management Approach on Segment Reporting

• Published date: 01 April 2015
• DOI: http://doi.org/10.1111/jbfa.12102
• Date: 01 April 2015

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 42(3) & (4), 310–366, April/May 2015, 0306-686X

doi: 10.1111/jbfa.12102

The Impact of the Management Approach

on Segment Reporting

MARTIN BUGEJA,ROBERT CZERNKOWSKI AND DARYL MORAN∗

Abstract: Accounting standard setters have increasingly attempted to align external segment

reporting disclosures to a firm’s internal reporting structure. We study how this move to the

management approach for segment reporting impacted the number of reported segments and

the extent of line item disclosures when Australia adopted IAS 14 (revised) and IFRS 8. We find

that both standards led to firms disclosing a greater number of segments. An examination of the

motives behind the non-disclosure of segments suggests that segment information was withheld

for agency cost reasons. We find only limited support for the proprietary cost motive for non-

reporting of segments. We also document that IFRS 8 led to a reduction in the amount of

line item disclosure. Consistent with a proprietary cost explanation, the decrease in disclosure

is greatest for firms with a higher number of profitable segments. Our results indicate that

the change to the management approach to segment identification is not associated with the

properties of analyst forecasts, nor did it lead to increased analyst following.

Keywords: disclosure, segment reporting, IFRS 8, IAS 14, analyst forecasts

1. INTRODUCTION

Segment reporting is the disaggregation of a reporting entity’s financial reports

into segments. Users of financial statements, such as analysts, claim that segment

information is essential in assessing and predicting firm performance (Knutson, 1993).

Managers, however, have incentives to report fewer segments externally than are

actually present within a firm to conceal industry diversity (Berger and Ofek, 1995)

and to minimise proprietary (Hayes and Lundholm, 1996 and Botosan and Stanford,

2005) and agency costs (Berger and Hann, 2007).1

∗The first author is from the University of Technology, Sydney. The second author is from University of

Technology, Sydney. The third author is from Visy Board, 6 Herbert Place, Smithfield NSW 2164 Australia.

This paper has benefited from comments received from an anonymous referee and participants at the

2012 American Accounting Association Annual Meeting, 2012 British Accounting and Finance Association

Conference, 2012 European Accounting Association Annual Congress and the 2014 Journal of Business

Finance & Accounting conference. The authors also acknowledge the research assistance of Stephanie Fohn

and Stephen Soco.

Address for correspondence: Martin Bugeja, Accounting Discipline Group, The University of Technology

Sydney, 2007, New South Wales,Australia.

e-mail: martin.bugeja@uts.edu.au

1 The contention that managers can manipulate the definition of segments to minimise segment disclosures

has been an issue recognised in prior studies over a long period of time. For instance, see Emmanuel and

Gray (1977) who discuss issues related to the initial release of SFAS No. 14 “Financial Reporting for Segments of

a Business Enterprise” in 1976.

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THE IMPACT OF THE MANAGEMENT APPROACH ON SEGMENT REPORTING 311

In response to criticisms that firms were aggregating segments for external re-

porting purposes, standard setters have moved towards requiring firms to disclose

segments in accordance with their internal reporting structure (i.e., the management

approach). For example, in 1998 the FASB introduced SFAS 131 “Disclosures about

Segments of an Enterprise and Related Information” which requires externally reported

segments to be defined consistently with the internal reporting structure of the

business. At the international level, these changes in reporting were implemented

partially in the change from IAS 14 “Segment Reporting” to the revised IAS 14 “Segment

Reporting”,2and then further in the change from IAS 14R to IFRS 8 “Operating

Segments”.3

This study has a number of objectives. First, we determine whether the adoption of

both IAS 14R and IFRS 8 resulted in an increase in the number of segments reported

externally. Second, we provide evidence on the incentives that explain which firms

revealed additional segments upon the adoption of both standards. Third, we take

advantage of the discretion in segment line item disclosure provided in IFRS 8 to

analyse potential motives for firms that reported less disclosure. Finally, we examine

whether the adoption of both IAS 14R and IFRS 8 improved the properties of analyst

forecasts.

There are three motivations for this study. First, US evidence subsequent to the

introduction of SFAS 131 indicates that the standard was successful in increasing

the number of reported segments (Street et al., 2000; and Berger and Hann, 2003).

However, studies which examine the reasons for the non-disclosure of segments

prior to SFAS 131 have provided mixed results. For example, Botosan and Stanford

(2005) find that the newly revealed segments under SFAS 131 were operating in

less competitive industries, which is consistent with a proprietary cost explanation

for the non-disclosure of segments. In contrast, Berger and Hann (2003, 2007)

report that newly disclosed segments were underperforming consistent with an agency

explanation for segment non-disclosure. Given these contrasting results, Berger and

Hann (2007) recommend that further evidence on the incentives of firms to aggregate

segments be obtained from non-US studies. This study contributes such evidence

by examining Australia’s adoption of two separate accounting standards which

were intended to shift firms’ external segment reporting towards the reporting

structure used internally within a firm.4

The second motivation for this study is to provide a comprehensive examination of

the impact on firm reporting of international standard setters moving their segment

accounting standards towards a management approach. Prior studies document that

the adoption of both IAS 14R (Street and Nichols, 2002) and IFRS 8 (Crawford et al.,

2012; and Nichols et al., 2012) led to firms reporting additional segments. Previous

research also indicates that IFRS 8 resulted in less segment line item disclosure

(Crawford et al., 2012; and Nichols et al., 2012). These studies however, typically

examine only a small sample of the largest listed firms. In contrast, we use a sample of

all Australian listed firms with available data to analyse the impact of both standards.

2 For ease of exposition, we hereafter refer to IAS 14 (revised) as IAS 14R.

3 A detailed discussion of the regulatory background is provided in section 2 of the paper.

4 By focussing on a single country (Australia) with an almost simultaneous adoption of each of IAS 14R

and IFRS 8, we avoid problems caused by varying cross-country institutional environments and cross-time

economic conditions.

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312 BUGEJA, CZERNKOWSKI AND MORAN

A further limitation with prior research examining the effect of IAS 14R and

IFRS 8 is that these studies are typically descriptive and do not attempt to analyse

possible motives for the reporting of additional segments or a reduction in line item

disclosure upon the adoption of IFRS 8. This study, however, attempts to provide

evidence on why firms reported additional segments or reduced line item disclosures.

In an ideal, full-disclosure world, management would report externally segments and

segment information consistent with the internal reporting structure of the firm.5

However, in the real world, firms are likely to report their segment information in

an optimal fashion which reflects a cost–benefit trade-off. As a result, firms for which

the perceived costs exceed the benefits, report more aggregated segments and less

segment information.6Based on prior research we argue that these trade-offs are

driven – at the margin – by agency and proprietary considerations and an incentive

to report less industrial diversity. Accordingly, we expect that a change in accounting

standards towards a more strict regulation of the segment identification process leads

to, on average, the disclosure of a greater number of segments.7We also expect that,

when accounting standards provide discretion as to the line items which need to be

disclosed, that some firms choose to reduce disclosure. Furthermore, we expect the

change in the number of reported segments and segment disclosures to be associated

with factors proxying agency and proprietary costs and industrial diversity.8

The final motivation for this study is to provide evidence on whether the move

internationally to the management approach for segment reporting resulted in an

improved information environment for users. This research question has largely

been unexamined in prior studies assessing the impact of IAS 14R and IFRS 8. We

address this gap in the literature by analysing whether the adoption of either standard

improved the properties of analyst forecasts. This investigation also adds to prior

US research (Berger and Hann, 2003; and Botosan and Stanford, 2005) which finds

inconsistent evidence on whether the adoption of SFAS 131 improved analyst forecast

accuracy.

Our evidence is based on a sample of 1,241 Australian Securities Exchange (ASX)

listed firms which adopted IAS 14R in 2002 and 1,617 ASX listed firms which adopted

IFRS 8 in 2009.9We conduct our investigation by taking advantage of the availability

5 This assumes firms arrange their internal reporting structure in a manner that provides management with

the most optimal information for decision making.

6 A maintained assumption of our study is that firms were previously under-reporting the number of

segments. Prior studies, (Piotroski, 1999, 2003) attempt to measure the extent of segment under-reporting

using SIC codes. However, historical SIC codes at the firm level are not available for Australian firms from

the Thomson Reuters Datatream database and as a result we are unable to conduct a similar analysis. In

the additional analysis section of the paper (section 5(v)), we make use of the narrative disclosures for a

subsample of firms in an attempt to assess segment under-reporting.

7 This expectation assumes that external auditors are able to access internal firm documents to ensure

compliance. Informal discussions with a small number of auditors, suggests that they are able to obtain

internal documents for auditing purposes. We leave it to subsequent research to examine this issue further.

8 Arguably, reporting segment information externally consistent with the internal reporting structure of

the business should reduce the workload of auditors in verifying the disclosures. We leave it to subsequent

research to examine the possible implications of the change in segment reporting for auditors (e.g., audit

fees).

9 IAS 14R was adopted in Australia in 2002 as a revised version of AASB 1005 “Segment Reporting”. This

revised standard was adopted as part of the Australian Accounting Standards Board’s (AASB) international

accounting standard convergence project and is equivalent to IAS 14R issued by the International Ac-

counting Standards Committee in 1997. In 2004, as part of Australia’s move from international accounting

standard harmonisation to adoption, the revised AASB 1005 was replaced by AASB 114 “Segment Reporting”,

for financial years ending on or after 1 January 2005. As AASB 114 was a direct copy of IAS 14R, it was

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