CHAPTER IV REVIEW OF LITERATURE - Shodhgangashodhganga.inflibnet.ac.in/bitstream/10603/37267/6/...Examination of Financial Reporting Fraud at the Segment Level ˛ studied to assess

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CHAPTER –IV

REVIEW OF LITERATURE

The aim of this chapter is to identify, describe and analyse the features of

factors related to segment reporting disclosure through literature review. The

conceptual and empirical articles on segment reporting disclosure are reviewed,

analysed and summarized. The assessment on International and National articles on

segment reporting disclosure in various countries forms the base for the research

framework discussed in the next chapter.

Prof. (Dr.) Sanjay Bhayani (2012) in his article titled, “The Relationship

between Comprehensiveness of Corporate Disclosure and Company Characteristics in

India”, studied to examine company characteristics and their influence on corporate

disclosure. His study aimed to determine which of the factors such as age of the

company, listing status of the company, ownership structure of the company, leverage

of the company, size of the audit firm, residential status of the company, size of the

company and profitability of the company were significantly related to increased

corporate disclosure. The author used the disclosure index to measure corporate

disclosure on a sample of forty five listed non-financial Companies of India. To

measure the association between the variables of the study, the author used Pearson

Correlation Matrix was used. The findings of the author in his study show that the

companies with large assets size, higher profitability, higher leverage, listing in

foreign stock exchanges, lower holding of promoters share and audited by big audit

Companies have tendencies to be more transparent and hence disclose more

information. The author in his study further reveals that age of a company and

residential status do not significantly influence the level of corporate disclosure.

Dr. Martin Onsiro Ronald et.al., (2011) in their article titled, ”Segment

Reporting (IFRS-14 and AS-17) : A Study of Commercial Banks in Kenya and India”,

say that Segment reporting requires companies especially those which are multi-

product and multi-location to disclose their segment-wise operations in their annual

reports as well as in their quarterly reports. Their study therefore is based on

identification of annual reports of 26 Indian commercial banks as well as 25 Kenyan

commercial banks and shows that segment reporting practices of these units have

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taken a new turn after the implementation of the standards (IAS-14/Indian AS-17

respectively). There is no difference between the disclosure practices of Indian

commercial banks and Kenyan commercial banks though they are adopting different

accounting standards. There is a need for convergence to IFRS so that global

understanding in the banking sector world over may develop.

Their findings represent that after the implementation of IAS-14 and Indian

AS-17, segment reporting practices of commercial banks working in India as well as

Kenya have increasingly taken a new turn, and are responding to the requirements of

the standard.

Mishari M. Alfaraih and Faisal S. Alanezi (2011) in their article titled,

“What Explains Variation in Segment Reporting? Evidence from Kuwait” evaluates

both the segment disclosure practice of Companies listed on the Kuwait Stock

Exchange (KSE) and the factors that influence their level of segment disclosures. The

results of this research paper show that the average level of segment disclosure in a

sample of 123 KSE-listed Companies in 2008 was 56 per cent, ranging from 18 per

cent to 94 per cent. The authors say that the Users of KSE-listed Companies’ financial

statements might reasonably expect greater segment disclosures from larger, older,

highly leveraged, and profitable KSE-listed Companies, as well as from Companies

audited by a Big Four Audit Firm. The findings provide feedback to the regulatory

and enforcement bodies in Kuwait on current segment disclosure practice among

KSE-listed companies and the factors that influence the level of segment disclosures.

Vakhrushina M A (2011) in his article titled, “Segment Reporting Analysis

Content and its Informative Value” say that the modern unstable economic

environment, the competitiveness arising in the individual economy branches and the

financial crisis make the commercial organisations to approach new management

technologies. Satisfaction of information inquires both of internal, and external users

– potential investors first of all, has become the purpose of drawing up and analysis of

the segment reporting. The author after considering requirement of the Accounting

Regulations 12/2000, has given the methodical aspects of the segment reporting

formation and the main stages of its analysis as well. The author concludes that the

accounting information analysis prepared by business segments, contributes to


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accepting investment decisions adequate to the current situation by a potential

investor.

Dana Hollie et.al., (2011) in their article titled, “A Forensic Accounting

Examination of Financial Reporting Fraud at the Segment Level” studied to assess

various financial reporting frauds that occurred at the segment-level. From a fraud

perspective, segment reporting has been an overlooked topic in both practice and

academia. The authors provide an analysis of fraud at the segment level at nine major

corporations. The primary goal of the Securities Exchange and Commission (SEC) is

to ensure that company-level earnings are truthfully reported, therefore segment-level

reporting, although compliant with Generally Accepted Accounting Principles

(GAAP), may be a secondary goal in SEC investigations since segment fraud rolls up

into company-level fraud.

The study describes company characteristics, types of fraudulent, and some of

the financial effects the fraud had on these Companies. The authors further provided

the details of various types of manipulations employed to perpetrate these frauds. The

study focuses only on segment financial reporting fraud that has led to the issuance of

an Accounting and Auditing Enforcement Release (AAER) that specifically

referenced fraud at the segment level.

Cho, Joong-Seok (2010) in his article titled, “Information Content Change

under SFAS No. 131’s Interim Segment Reporting Requirements”, empirically

investigates the effect of implementation of SFAS No. 131 on companies’ information

environments by assessing the effect of interim period financial reports. Using

Beaver’s information content measures, the author investigate the market’s reaction to

interim period financial reporting under SFAS No. 131. The empirical results of the

information content test show that the adoption of SFAS No. 131 does not affect the

market’s reaction. For the price test, the author found no difference in the reaction to

the interim financial statement filing for both voluntary and non-voluntary

disclosures. This result gives evidence that the information content of the new

requirements of interim financial reporting is not significantly different from that

under the previous requirements.


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Louise Crawford, Heather Extance, Christine Helliar and David Power

(2010) in their article titled, “Slicing up the data” discuss that as part of its

convergence process with the Financial Accounting Standards Board (FASB), the

International Accounting Standards Board (IASB) issued IFRS 8 Operating Segments

to replace IAS 14 (Revised) segment reporting in 2006. IFRS converges with its US

counterpart, Statement of Financial Accounting Standard (SFAS) 131, except for

minor differences and terminology changes necessary to conform to other IFRSs.

The core principle of IFRS 8 requires an entity to “...disclose information to

enable users of its financial statements to evaluate the nature and financial effects of

the business activities in which it engages and the economic environments in which it

operates”. To implement this principle, IFRS 8 specifies that Companies only publish

information about those segments that management use internally when making

operating decisions. This “management approach” requires identification of

“operating segments” based on internal reports and permits non-IFRS measures of

segmental items to be used; this approach differs from IAS 14 (Revised), which

required that primary and secondary segments be identified on a risks and returns

basis, using IFRS-compliant measures, as either business or geographic activities.

According to the current findings, the management approach of IFRS 8 has

been associated with an increase in the average number of both business and

geographic segments for which information has been disclosed.

Pontus Troberg et.al., (2010) in their article titled, “What drives cross-

segment diversity in returns and risks? Evidences from Japanese and US Companies”

say that the usefulness of segment reporting is grounded all the presumption of

diversity of returns and risks across reported segments. They examined the effect of

country specific factors reporting incentives, and choices on ANOVA-based measure

of cross-segment diversities (CSD) in risk and returns for a sample of Japanese and

US multi-segment Companies. The Authors found that Japanese Companies exhibit

greater CSD then US Companies. They also found that in both countries CSD is

driven especially by reporting incentives associated with profitability and foreign

sales, but not by proprietary costs. Further, the authors propound that the manager’s

choice of the number of reported segments is an important factor affecting CSD.


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Samuel Jebaraj Benjamin et.al., (2010) in the article titled “A Study of

Segment Reporting Practices: A Malaysian Perspective” revealed that the increasing

complexity of business enterprises and the growing popularity of conglomerate type

businesses, it has become clear that consolidated financial statement reporting, while

obviously necessary, may not necessarily provide users with sufficient insights for the

making of informed decisions. They further say that Segment Reporting is

fundamentally indispensable and integral to investment analysis process (AIMR,

1993, pg 39; Berg 1990). Their study highlights the evidence on a fraction of

Malaysian companies that do not provide any segment reports at all in contrast to their

direct competitors who comply. The study also found that the proprietary costs motive

theory seem to hold true for the selected companies, where companies which

experience high profit margin are the ones who choose not to disclose segment

information. The consequences of non-disclosure of FRS 114 by Malaysian

Companies has far reaching impacts, right from valuation of shares, to corporate

governance and control mechanism (Burger and Hann, 2003: 2007). The adoption of

suggestions recommended by this study is expected to solve this reporting problem to

a certain extent, if not completely. The eventual outcomes of the effectiveness of the

new FRS 8 in solving this problem mentioned above would be of great interest to

financial analysts and general users.

Barry Epstein and Eva Jermakowicz (2009) in their article titled, “IFRS

Converges to US GAAP on Segment Reporting”, says that IFRS 8 applies to the

individual financial statements of an entity and the consolidated financial statements

of a group with a parent (a) whose debt or equity instruments are traded in a public

market or (b) that files, or is in the process of filing, its financial statements with a

securities commission or other regulatory organization for the purpose of issuing any

class of instruments in a public market. Reportable segments are operating segments,

or aggregations of operating segments, that meet or exceed one of several quantitative

thresholds; similar segments may be optionally disclosed.

The authors further discuss that IAS 14, dual segment classifications were

required – by both business and geographic area – with the primary typology

determined by the predominant driver of the reporting entity’s risks and returns.

Under IFRS 8, operating segments may be defined by product, geography or other


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attributes – consistent with management’s decision-making processes. IFRS 8 allows

for the discrete reporting of a component of an entity that sells primarily or

exclusively to other operating segments of the entity so long as the entity is actually

being managed consistent with that strategy. This means that vertically integrated

operations may be composed of several segments for the purpose of IFRS 8.

Derarca Dennis (2009) in his article, “Operating Segments Through

Management’s Eyes”, says that IFRS 8 Operating Segments, (‘the standard’) aligns

the identification and reporting of operating segments with internal management

reporting. The author further states that Segment Reporting under IFRS 8 should

highlight the information and measures that management believes are important and

are used to make key decisions. It should also provide a better link between the

financial statements and the information reported in management commentaries such

as the Operating and Financial Review. The standard converges IFRS with US

Accounting Standard SFAS 131 ‘Disclosure about Segments of an Enterprise and

Related Information’.

Mohammed Talha et.al., (2009) in their article titled, “Segmental Reporting

and Competitive Disadvantage: A Study of Malaysian Companies”, aimed to

investigate whether competitive disadvantage is experienced by Malaysian

Companies as they disclose segmental information under the new accounting standard

known as FRS 114, Segment Reporting. Four hypothesis were developed to examine

the relationship between segmental reporting disclosure and competitive

disadvantage. The logistic regression model was employed to test the formulated

hypothesis. The results revealed four main points: (a) smaller companies experience

greater competitive disadvantage than larger companies as they disclose segment

information; (b) disclosing the business segment as the primary segment does not lead

to greater competitive disadvantage; (c) companies which are highly leveraged do not

experience greater competitive disadvantage as they disclose segmental information;

(d) there is no significant association of competitive disadvantage with industrial

membership. The insights of the study benefits various interested stakeholders, as

Malaysian Companies adopt the new FRS 114.

Ole-Kristian Hope et.al., (2009) in their article titled, “Geographic Earnings

Disclosure and Trading Volume” say that beginning with Statement of Financial


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Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an

“Enterprise and Revised Information, most US multinational Companies no longer

disclose geographic earnings in their annual reports. Given the recent growth in

foreign operations of US Companies and the varying operating environments around

the world, information (or lack thereof) related to geographical performance can

affect investors’ information set. Specifically, using a sample of Companies with

substantial foreign operations, they found evidence of a decrease in event period

private information following adoption of SFAS 131 for Companies that no longer

disclose geographic earnings. These results suggest that decreased public information

(i.e., non-disclosure of geographic earnings) reduces the ability of investors to utilise

or generate private information in conjunction with the public announcement of

quarterly earnings, which dampens trading. The authors also found evidence of a

decrease in pre-announcement private information following SFAS 131. This is

consistent with an overall improvement in public disclosures that has the effect of

reducing differences in the precision of private information across investors in the

period prior to the earnings announcement. However, the authors defend that such an

effect is observed for both Companies which no longer disclose geographic earnings

and for Companies that continue to disclose geographic earnings.

Kanogporn Narktabtee and Manatip Chankitisakul (2007) in their article

titled, “Segment Reporting Compliance of The Listed Companies in Thailand”,

examines segment reporting practices of the listed company during 1994-2005 by

using the TAS No. 24 segment reporting as a benchmark. The study focuses on

segment determinations and the segment information disclosed in the notes to

financial statements. The results show that the number of Companies presenting

information by multi-segments is growing and most companies report operating

segments by industry lines more than by geographical areas. The results also show

that problems of compliance with the existing accounting standard exist. Thai

Companies define their segments broadly and more than 50 per cent of sample

Companies do not fully disclose accounting information required by the TAS No.24.

The authors in their study, discuss the possible explanations of these practices and

reflects on implications to parties, listed companies and related regulators.


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Nancy B Nicohols and Donna L Street (2007) in their article titled “the

relationship between Competition and Business Segment Reporting decisions under

the Management Approach of IAS 14 Revised”, addresses the relationship between

industry competition and managers’ choice regarding whether to separately disclose a

business segment following the adoption of International Accountant Standard 14

Revised (IAS 14R) and the management approach to segment determination. Logistic

regression reveals a significant negative relationship between disclosure and company

returns in excess of the industry average. Their results provide evidence that this

flexibility persists as managers maintained that they ability to aggregate segment to

protect excess returns under IAS 14R and management approach. Their finds are

timely as the IASB plans to modify its segment reporting requirements as part of the

Board’s convergence agenda and as thousands of companies worldwide, effective

from 2005 onward have started preparing financial statements using IFRS.

Paul Robins (2007) in his article titled, “IFRS 8, Operating Segment”, stated

that IFRS 8 defines an operating segment as a component of an entity : (a) that

engages in revenue earning business activities, (b) Whose operating results are

regularly reviewed by the chief operating decision maker and (c) for which discrete

financial information is available. Once an operating segment has been identified, the

entity needs to report segment information if the segment meets any of the following

quantitative thresholds:

Its reported revenue (external and inter-segment) is 10 per cent or more of the

combined revenue, internal and external, of all operating segments; Its reported profit

or loss is 10 per cent or more of the greater, in absolute amount, of (i) the combined

profit of all operating segments that did not report a loss and (ii) the combined loss of

all operating segments that reported a loss or its assets are 10 per cent or more of the

combined assets of all operating segments.

Sanjiv Agarwal (2007) in his article “Segment Reporting by Banks”

specifically indicates that the most of the public sector banks have been following the

RBI directions on clarification of business segments while a few private sector banks

have been reporting as per the AS-17. He further says that when it comes to segment

reporting by banking companies, there is a clash of norms- that is between


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Accounting Standard (AS-17) stipulated by the Institute of Chartered Accounts of

India and those issued by the Reserve Bank of India.

AS-17 on segment reporting is mandatory, and is specified in the accounting

standard itself. A business segment is a distinguishable component of an enterprise

that is engaged in providing an individual product, service or a group of related

products or services and that is subject to risks and returns that are different from

those of other business segments. The factors which should be considered in

determining whether products and services are related include: (i) the nature of the

products or services, (ii) the nature of the production process, (iii) the type or class of

customer for the products or services, and (iv) the methods used to distribute the

products or provide the services.

Allen I Schiff et.al., (2006) in their article titled, “Segment Reporting

(Portfolio 5119)”, explains and analyses the disclosure and reporting requirements of

FASB Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures

About Segments of an Enterprise and Related Information, and discusses other

applicable pronouncements and the related accounting and reporting requirements of

the US Securities and Exchange Commission (SEC).

The portfolio illustrates and analyses key issues in segment reporting,

including analysing segment ratio using the accrual and cash flow ratio, utilising

segment and equity data to analyse the purchase and subsequent performance of an

acquired segment, and reporting segments in the management disclosure and analysis

section of the annual report. This portfolio summarizes the history of segment

reporting and compares SFAS 131 with international accounting guidance on segment

reporting.

David Harper (2006) in his article titled, “The Importance of Segment Data”,

say that Large-cap companies are thought to be safer while it comes to segment

disclosures than less-capitalized companies, because they are more diversified and

liquid than smaller companies. The average large-cap company is a multi-dimensional

amalgamation of dizzying complexity and breadth. If a large-cap company is to be

evaluated, in most cases the key financials (e.g. revenues, margins, returns) are just a

starting point. For most large caps, corporate-level metrics are aggregates that


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combine the performance of several different units. The authors insist that the best

companies are the ones that are incubating high-growth units within the overall

organization. The author finally suggests that every company should start to prepare

the financial statements by disclosing the segment information to understand the

business better.

George T Tsakumis et.al., (2006) in their article titled, “Competitive Harm

and Geographic Area Disclosure under SFAS 131”, say that the potential competitive

harm associated with country specific disclosure provides an incentive for

management to avoid making these disclosures. Specifically, the authors hypothesis

that Companies with higher potential competitive harm costs will provide less

detailed geographic area disclosures. Their results show that, company exposed to

greater competitive harm costs provide less detailed country specific revenue

disclosures. The study helped to explain the diversity in practice with respect to the

level of detail provided by companies in their geographic area disclosures under

SFAS 131. In addition it adds to the literature examining the impact of potential

competitive harm on disclosures made by US Companies, by extending the line of

research through geographic area disclosures.

Ole-Kristian Hope et.al., (2006) in their article titled, “The Impact of Non-

Disclosure of Geographic Segment Earnings on Earnings Predictability”, address

whether nondisclosure of geographic segment earnings after implementation of

Statement of Financial Accounting Standards No. 131 (SFAS 131) has an impact on

the earnings predictability of multinational companies. An understanding of how

nondisclosure of accounting information affects the predictability of a company’s

earnings will be of importance to financial statement users, managers, auditors, and

standard setters. The quality of geographic disclosures is especially important as

foreign operations represent a growing portion of many U.S. multinational companies

and these operations can vary considerably on risk and return characteristics.

Companies that define their operating segments on any basis other than geographic

area are no longer required to disclose geographic earnings. The authors find that

nondisclosure of geographic earnings has no effect on analysts’ forecast accuracy or

dispersion. The authors conclude that the Financial Accounting Standards Board’s

decision to no longer require disclosure of geographic earnings for secondary


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segments has not hampered users’ ability to predict earnings of U.S multinational

companies.

Botosan, Christine A, et.at., (2005), in their article titled, “Managers motives

to withhold segments disclosures and the effect of SFAS No.131 and SFAS No.14 on

analysts’ information environment(Statement of Financial Accounting Standard)” say

using retroactive disclosures required by Statement of Financial Accounting

Standards (SFAS) No.131, managers’ incentives for withholding segments

information under SFAS No.14 and impact of SFAS No.131 on analysts’ information

environment for a sample of Companies that previously reported as single-segment

Companies initialed segment disclosure with SFAS No.131. the author examined this

set of Companies because they likely had the strongest incentives to withhold segment

information and analyst potentially had the most to gain when these Companies were

forced to begin providing segment disclosure under SFAS No.131. the authors found

that these Companies used the latitude in SFAS No.14 to hide profitable segments

operating in less competitive industries then their primary operations. However, they

found no evidences to suggest that these company used the latitude in SFAS No.14 to

mask poor performance. In contract, their results suggest that by withholding segment

information, these Companies allowed themselves to appear as if they were under

performing their competition when this were not the case. Thus their discussion to

withhold segment disclosure under SFAS No.14 appears to be motivated by a desire

to protect profit in less competitive industries. The terms of the impact of the SFAS

No.131 on analysts’ information environment, their evidence suggest that SFAS

No.131 increased analysts’ on public data, but they provide weak evidence to suggest

that this shift may have come at the cost a marginal increase in overall uncertainty and

squared error in the mean forecast.

Ettredge, Michael L et.al., (2005) in their article titled “ The impact of SFAS

No.131 business segment data on the market’s ability to anticipate future earnings”

investigates the effect of Companies’ adoption of SFAS No.131 segment disclosure

rules on the stock markets’ ability to predict the Companies’ earnings, as captured by

the Forward Earnings Response Coefficient (FERC). The FERC is the association

between current-year returns and next-year earnings. SFAS No.131, effective for

fiscal years beginning after December 15, 1997, arguably increased both the quantity


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and quality of segment disclosure. Consistent with standards’ intended qualitative

effects, pre-131 multi-segment Companies experience a significant increase in FERC

after adopting SFAS No.131. Consistent with the standards’ intended quantitative

effects, many pre-131 single-segment Companies begin disclosing multiple segment

and those that did experienced an increase in FERC. However, pre-131 single-

segment Companies that remained single-segment (i.e., were unaffected by SFAS

No.131) had no change in FERC, indicating that the increase in FERC for 131-

affected Companies is not due to some other event concurrent to the adoption of

SFAS No.131. These results are robust under numerous procedures that control for

the characteristic of the sample Companies and their earnings, providing strong

evidence that SFAS No.131 resulted in increase in stock price informativeness for

affected Companies. Thus, the authors provide the first empirical price-based

evidence that SFAS No.131 provided more information (about future earnings) to the

market, as the standard’s proponents have suggested.

Jack W Paul and James A Largay (2005) in their article titled, “Does the

‘Management Approach’ contribute to Segment Reporting Transparency?”, discuss

on how segment reporting creates an opportunity for companies to add value to the

information they disseminate about their industry and geographic operations. The

authors examine the ‘Management Approach’ to segment reporting from a user

perspective that should be of great interest to corporate financial executives. The

management approach to segment reporting requires companies to report segment

financial information consistent with the way they manage their businesses. The

authors conclude that, despite more segment data being reported, the potential of the

new management approach to significantly benefit users is compromised by uneven

compliance among reporting companies. The complicity of external auditors in

compliance shortcomings should concern all stakeholders in the financial reporting

process. Noting two high profile examples of accounting fraud, the authors comment

on how the management approach sheds light on Enron’s operations, while

WorldCom concealed important segment information due to probable auditor

malfeasance.

Winston Chee Chiu Kwok and David Sharp (2005) in their article titled,

“Power and International Accounting Standard Setting: Evidence from Segment


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Reporting and Intangible Assets Projects”, provides significant empirical data and

analysis on the international standard-setting process as conducted by the forerunner

of the International Accounting Standards Board (IASB). It reveals the influences

from four key stakeholder groups (Users, Preparers, Accountants and Regulators) in

order to ascertain why International Accounting Standards (IAS) turn out the way

they do. The authors conducted in-depth interviews with board representatives and

content analysis of documents were used to provide triangulating perspectives The

concept of power from the sociological and political science literature provides the

theoretical lens. The standard setting projects on segment reporting and intangible

assets were studied in detail. The results show that the process can be best

characterised as a mixed power system where no party is accorded the absolute power

potential to dictate IAS. Nonetheless, while the user group is the target beneficiaries

of IAS, the preparer group has significant influence, as inferred from the changes

made to the IAS in line with the preparers’ preferences. After this study, the IASB’s

meetings became open to public, providing new opportunities for future research. The

study contributes to understanding accounting standard setting for international

harmonization.

Annalisa Prencipe (2004) in her Research article titled, “Proprietary costs

and determinants of voluntary segment disclosure: evidence from Italian listed

companies” aims to identify new determinants of the extent of voluntary disclosure by

using the theoretical framework of the proprietary costs theory, which states that

companies limit voluntary disclosure because of proprietary costs, such as preparation

and competitive costs. She further says that on the basis of the existing literature on

this theory and on segment reporting, three hypotheses are theoretically derived, each

correlating the level of segment disclosure to a new determinant, specifically the

correspondence between the segments and legally identifiable sub-groups of

companies, the growth rate and the listing status age.

The paper also provides further evidence to test the impact of some

‘traditional’ determinants, introduced in the study as control variables. The

hypotheses formulated are empirically verified. The author has carried out her

analysis with reference to Italy, because of its limited legal and professional

provisions on the topic. For the empirical test, the author has selected a sample of


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sixty-four Italian listed companies and a multiple regression model is used. Results

from the study show that , except for the growth rate, the two other new determinants

are significantly related to the extent of segment disclosure. According to the author,

these findings confirm that proprietary costs are particularly relevant and limit the

incentive for companies to provide segment information to the market.

Jenice J Prather and Gary K Meek (2004) in their article titled, “The Effect

of Revised IAS 14 on Segment Reporting by IAS Companies”, conducted a study to

determine how IAS 14R affected the segment disclosure practices of companies

claiming to comply with IAS. They examined the following questions : (1) What

items of information are disclosed under IAS 14 and IAS 14R? Was there a gain or a

loss of information disclosed for business and geographic segments with the

implementation of IAS 14R? (2) Has the number of business and geographic

segments reported by companies changed with the implementation of IAS 14R? (3)

Are companies disclosing the items required by IAS 14R? (4) Are companies’

segment reporting practices related to size, country of domicile, industry, international

listing status and having a then-Big 5 auditor? They found that the impact of IAS 14R

is mixed. Companies are responding to IAS 14R, but not wholly embracing it. Their

findings suggest that companies audited by a Big 5 (now Big 4) company and, to a

lesser extent, companies that are larger, listed on multiple stock exchanges, and from

Switzerland have greater compliance with IAS 14R than other companies.

Palanisamy Saravanan et.al (2004) in their article titled, “Are Recent

Segment Disclosures of Indian Companies Useful? An Empirical Investigation” states

that the ultimate objective of the financial statement is to give reliable information,,

which is to be relevant and therefore useful in economic decision making. Thus a

company which operates in different industrial sectors and geographical areas need to

provide information about its various segments and the relative importance of each in

order to understand the company, the economic environment in which it operates and

the development of the situation of the company. The authors claim that their study

contributes to the existing literature by providing some of the first evidence on the

usefulness of segment disclosures in developing countries especially in the Indian

context. The authors state that since 01.04.2001 the Securities and Exchange Board of

India (SEBI) required the Indian Companies to disclose segment data in their annual


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financial statements. ICAI have come out with AS-17 that deals with Segment

Reporting.

The authors used a survey instrument to examine whether the Indian Investors

find these segment disclosures useful. In their study they found that Indian Investors

perceive that segment data aid them in forecasting consolidated sales and net income.

However, the results also show that investors are concerned that Indian Companies do

not define segments meaningfully and consistently and are arbitrary in the allocation

of common cost. These results have implications in Indian Stocks. Financial Analysts

and other regulatory bodies such as Institute of Chartered Accountants of India

(ICAI), Securities and Exchange Board of India (SEBI), Ministry of Finance (MoF)

and Department of Company Affairs (DCA).

Larry P Seese and Timothy S Doupnik (2003) in their article titled “ The

materiality of country-specific geographic segment disclosures” discussed that SFAS

131 (1997) substantially changed geographic segment reporting in the US by required

disclosures to be made by individual foreign country when operations in an individual

country are material. Although SFAS 14 (1976) provided a quantitative threshold for

determine separately reportable segments, SFAS 131 provides no guidance for

determining when operations in an individual country are material. In SAB 99 (1999),

the SEC reminds Companies that exclusive reliance on quantitative benchmarks to

assess materiality in appropriate; qualitative factors also should be considered.

Susanne Homolle (2003) in her article titled, “From the Theory of Financial

Intermediation to Segment Reporting : The Case of German Banks”, say that a

growing number of German Banks have disclosed segmental data according to IAS 14

(revised 1997), which, however, does not consider any specific features of banks. The

author has derived demands for banks’ segment reporting from the microeconomic

theory of financial intermediation and give some advice how banks could improve

their segment reporting. The new German Accounting Standard GAS3-10, Segment

Reporting of Banks, does not fully meet their requirements. The author suggests that

the standard should be reformed with respect to various deficiencies to become a

guideline of segment reporting not only for German, but for international banks as

well.


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Behn, Bruce K et.al., (2002) in their article titled, “the predictive ability of

geographic segment disclosures by U.S companies: SFAS No.131 vs. SFAS No.14.” ,

considers whether recent modifications to segment reporting adequately address

analysts’ concerns regarding the usefulness of geographic data. Forecast errors for

models utilizing SFAS No.131 geographic sales data are compared to forecast error

for models utilizing SFAS No. 14 geographic sales data. The results indicate a

significant improvement in the predictive accuracy of geographic sales disclosures

provided under SFAS No.131. Additional analysts such as this enhanced

predictability may be associated with revised requirements that companies report sales

for the country of domicile and each individually material country. The findings of the

authors appear to support the FASB’s argument that segment information by country

is more informative and useful. Based on their findings, recommendations were

presented regarding possible amendments to a SFAS No.131 that may further enhance

the predictive ability of geographic segment data.

Donna L Street and Nancy B Nichols (2002) in their article titled, “LOB and

Geographic Segment Disclosures : An Analysis of the Impact of IAS 14 Revised”, say

that to better satisfy important information needs of users of financial statements, as

set forth in the IASC Framework, the IASC issued IAS 14 revised (IAS 14R),

Segment Reporting in 1997. IAS 14R became effective for fiscal years beginning on

or after July 1, 1998. The authors examine the pre-IAS 14R and post-IAS 14R line of

business (LOB) and geographic disclosures of a global sample of companies that refer

to IAS to ascertain the impact and effectiveness of IAS 14R in practice. Specifically,

the authors consider whether the new requirements resulted in (1) a greater number of

LOB segments for some enterprises, particularly those that previously claimed to

operate in one LOB, (2) more meaningful, transparent geographic groupings, as

operated to the vague groupings associated with the original version of IAS 14, (3)

companies reporting more items of information about each LOB and/or geographic

segment, and (4) improved consistency of primary segment information with other

parts of the annual report. Additionally, the authors examine the extent to which IAS

companies provided voluntary segment disclosures and suggests some problems

associated with compliance.


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Nichols, Dave L et.al.,(2002) in their article titled, “Geographical segment

disclosures for the petroleum industry under SFAS 131”, say the general standard

SFAS 131 specifically requires companies to define operating segments on a basis

that is used internally for decision making (i.e., “the management approach”). The

authors further specify that in addition to the management approach, SFAS 131 also

requires more detailed information for each reported segment, including significant

non cash items other then depreciation depletion and amortization. Finally, SFAS 131

requires companies to disclose limited segment information in interim financial

statements. When adopting SFAS 131,companies must restate prior period SFAS 14

geographic segment data.

The author propound that regarding geographic segment information, SFAS

14 did not specify a single method of grouping regions. FASB identified factors that

were to be considered in determine the geographic areas. Those factors included

proximity, economic affinity, similarity in business environments and the nature,

scale and degree of inter relationship of the enterprise’s operations in various

countries.

Steve Lawrence (2002), in this article titled, “convergences on the UK GAAP

to IAS – GROUP ACCOUNTING” has discussed the need for convergences in :

the format of financial statement (eg., balance sheet and profit and lost account), the

disclosure of cash flow information; segmental data reporting; the need to expose

related party transaction; and the calculation of one of the most important

performance indicators, Earning Per Share(EPS).

Earning Per Share(EPS) is a vital performance indicator and effects have been

made to harmonies the rule governing the computation of the two main EPS ratio,

basic and diluted.

The author in his article opines that the segmental reporting is one that related

to the presentation and disclosed or information, by reference to distinguishable

components of the reporting entitle. This form of reporting requires the determination

of what is a reportable component (segment) and what information is to be disclosed

by each segment.


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Vivek Mande and Richard Ortman (2002) in their article titled, “The effect

of Japanese Business Segment Reporting on Analysts’ Forecasts: Implications for US

Investors and the SEC”, say that Japan has required that business segment data be

disclosed in annual financial statements since 1990. The study examines the

information content of business segment disclosures of multi-segmented Japanese

Companies on the Nikkei 225 index. Specifically, the authors test whether Japanese

analysts’ forecast accuracy of consolidated sales and net income improves following

the disclosure of segment data. The study finds that the introduction of the segment

reporting standard aids analysts in forecasting sales of well-diversified Companies,

but there is no improvement in the forecast accuracy of earnings. The authors

conclude from the results that financial analysts do not generally find Japanese

segment disclosures to be useful in their equity analysis. These results have

implications for US investors and the US Securities and Exchange Commission which

allows Japanese Companies to list on US exchanges using Japanese segment reporting

standards.

Chikako Ozu and Sidney J Gray (2001) in their article titled, “The

Development of Segment Reporting in Japan: Achieving International Harmonization

through a process of National Consensus” explored the process by which Japanese

accounting has moved towards international harmonization in respect of its segment

reporting requirements. The segment reporting issue offers an interesting case

because, despite the strong opposition of companies in Japan, the new legislation

came into existence relatively quickly and was sequentially developed by the

regulators through a consensus building process. The most important influence in this

process was the Ministry of Finance (MOF) which directed the sequence of events

leading to the introduction of segments disclosure standards, with the Business

Accounting Deliberation Council (BADC) serving as a channel of communication

with various non-governmental parties involved. The authors further observed it is

also noteworthy that segment reporting appears to have been seen as an essential

element in the completion of the group accounting legislation in Japan which has been

the subject of growing international pressure.

Jordan, Charles E el.al., (2001) in their article titled “ SFAS No.131 results

in increased segment reporting for banks” say that effective in 1998, Statement of


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Financial Accounting Standards (SFAS No.131) ‘Disclosures about Segment of

Enterprise and Related Information’, dramatically altered the reporting requirements

for business segments. A company could easily define a line of business so broadly as

to encompass its entire operations under one segment result in no segment reporting

under SFAS No.14.

In SFAS No.131, the FASB attempted to address this concern by changing the

definition of the segment. Segment are now delineated for financial statement

disclosure consistent with how management organises a company for purposes of

making internal resource allocation decisions and performance evaluations the

authors’ proponent that the result should be an increase both in number of companies

reporting segments and in the diversity of the types of segment reported. The authors

examined how SFAS No.131 changed the segment reporting in the banking industry

related to SFAS No.14, based on an examination of several banks providing segment

disclosures under SFAS No.131.

Thimothy S Doupink and Larry P Seese (2001) in their article titled,

“Geographic Area Disclosures under SFAS 131: Materiality and Fineness”, describes

and evaluates certain aspects of the enterprise-wide geographic area disclosures

provided by fortune 500 companies in the implementation of SFAS 131, “Disclosures

about Segments of an Enterprise and Related Information”. The first objective of the

study was to determine how companies are complying with the materiality criterion of

SFAS 131 for determining when an individual country is reportable. The second

objective was to evaluate whether foreign operation disclosures provided by

companies in accordance with SFAS 131 result in a finer set of information than was

provided under SFAS 14. The results suggest that there is considerable diversity

among companies in the way that materiality is defined, with a majority of companies

that provide country-level disclosures using quantitative thresholds less than 10 per

cent. For a large percentage of companies, the information provided under SFAS 131

appears to be finer than the information provided under SFAS 14. However, a

significant minority of companies has taken a step backward in this regard.

Don Herrmann and Wayne Thomas (2000) in their article titled, “A Model

of Forecast Precision using Segment Disclosures: Implications for SFAS No.131”,

models the use of segment information in forecasting earnings. The Model derives


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four conditions under which segment information is expected to increase earnings

forecast precision. Forecast precision should increase with (1) greater differentiation

across segment forecast factors (i.e., expected segment growth, expected inflation,

political risk), (2) greater disaggregation of earnings, (3) greater predictive accuracy

of segment forecast factors, and (4) greater accuracy in measuring the segment

weights. The analysts’ of each condition includes an important implication regarding

the potential contribution of the new standard for segment disclosures, SFAS No.131,

in improving the usefulness of segment information from a forecasting perspective.

Nancy B Nichols et. al., (2000) in their article titled, “ Geographic Segment

Disclosures in the United States: reporting practices enter a new era”, say that the

promulgation by the FASB of SFAS 131, Disclosures about Segments of an

Enterprise and Related Information, in 1997 (FASB, 1997) (effective 1998) heralded

a new era of segment reporting in the United States. The authors were keen to assess

the impact and effectiveness of the new standard with reference to geographic

segment disclosures. Given the criticisms of its predecessor, SFAS 14, relating

segment identification and the consistency of internal and external reporting, the key

issue is the extent to which companies have responded to the changes in geographic

information disclosures required by SFAS 131. And empirical study of the 1997 and

1998 annual reports of US Global 1000 companies reveals mixed results. While more

countries specific data is disclosed and the consistency of disclosures with other parts

of the annual report is increased, the problem of reporting highly aggregated

geographic areas remains for a significant group of companies.

Neil Garrod (2000) in his working paper titled, “Competitive Disadvantage

and Segmental Disclosure”, say that multinational and multi-activity companies have

come under increasing pressure over the last decade to disclose segmental information

in their financial statements. Many companies have resisted increased disclosure for

several reasons. However, the most important perceived problem is that a competitive

disadvantage arises from disclosure. In this paper, the author establishes empirically

whether such a competitive disadvantage can be identified. The results suggest that

any competitive disadvantage suffered by companies from disclosing segmental data

is extremely limited. Any effect appears to be restricted only to geographic segmental


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disclosure. There is no evidence that the size of companies nor the jurisdiction under

which companies report influences this relationship.

Sudipta Basu et.al., (2000) in their article titled, “The Usefulness of Industry

Segment Information”, identifies segment characteristics that make industry segment

reporting more useful in equity valuation. Those characteristics are the difference in

segments’ growth potential, the relative size of segments and the magnitude of

correlation in segment earnings. The authors specify that usefulness is measured by

examining the percentage increase in R2 and the incremental coefficient of earnings in

regressions of stock returns on disaggregate segment earnings relative to aggregate

earnings.

Stan Clark, Joe Sanders and Sherman Alexander (1999) in the article titled

“New Segment Reporting. Is it Working?” say that broader disclosure rules have not

been adopted uniformly by all. And suppliers, buyers and competitors seem to be

benefiting as much as investors, creditors, and security Analysts.

The new segment reporting rules were supposed to quell cries from investors,

creditors, and security analysts that the company’s were not disclosing enough

segment information. They complained that segments were defined too broadly and

subjectively, resulting in too few industry segments. So, the Financial Accounting

Standards Board (FASB) introduced the new Statement of Financial Accounting

Standards (SFAS) No. 131, “Disclosures about Segments of an Enterprise and Related

Information”. Its intent was to make the companies more transparent to outsiders.

That’s why SFAS No. 131 is called a “management approach” to segment reporting.

It enables outsiders to see the enterprise through insiders’ eyes, helping them better

predict the company’s future cash flows. It does this by aligning internal with external

financial reporting at least as far as segment accounting is concerned.

Dan Givoly et.al., (1999) in their article titled, “Measurement Errors and

Information Content of Segment Reporting”, assess the quality of segment reporting

using a measure based on the correlation between the performance of the segment and

its industry. Their findings show that the quality of segment information particularly

earnings is lower than that of standalone Companies. The difference is attributed both

to measurement errors as well as to the operational structure of multi-segment


85

Companies. The result also suggest that stock market considerations and political

costs play a role in segment reporting. Market tests indicate that the information

content of segment information is inversely related to its quality.

Albrecht, W David et.al., (1998) in their article titled, “New segment

reporting”, say because many companies were not providing expected segment

information, the FASB has to be replaced SFAS No.14 with SFAS No.131. Under this

new standard, segments are defined from a management perspective- how

management organizes segments within the enterprise for making decisions and

assessing performance. The authors believe that although the two standards go in

different direction both accounting groups have made right decisions.

Charalambos T Spathis (1997) in his article titled, “Segment Reporting:

Theoretical Analysis and Empirical Approach in Greek Enterprises”, examines the

usefulness of segment reporting for a company’s internal information and for

providing information to external users. The principal problem, the method used to

prepare and issue segment reporting by the larger Greek enterprises, is identified and

clarified. There are two main areas of concern that the author tries to proclaim while

framing the objectives. The first refers to the proposed method of preparation and

issue of segment reporting, scientifically acceptable according to the Generally

Accepted Accounting Principles, principal national and international accounting

standards, given the particular financial, legal and taxation characteristics and the

Greek General Accounting Plan holding for Greek enterprises. The second,

concerning research into the practices applied by Greek Companies, refers to the

preparation of segment reporting for internal use, based on their particular

characteristics.

Laureen A Maines et.al., (1997) in their article titled, “Implications of

Proposed Segment Reporting Standards for Financial Analysts’ Investment

Judgments”, reports results from an experiment which provide evidence on how

certain provisions of current and revised segment reporting standards affect financial

analysts’ judgments. Specifically, the authors examine the effect of two alternative

approaches to segment definition : Segments defined by grouping similar products

(similarity approach) and Segments defined by a company’s internal reporting

classification (management approach). The first approach is used currently under


86

SFAS No. 14 as the basis for determining externally-reported segments, while the

second approach is used after December 15, 1997, the effective date of the FASB’s

new segment reporting standard, SFAS No. 131, Disclosures about Segments of an

Enterprise and Related Information. Results show that analysts perceived segment

reporting to be more reliable when similar products were combined in a segment

(SFAS No. 14) than when dissimilar products were combined, and when external

segments were the same as those used internally (SFAS No. 131) than when external

and internal segments differed. Analysts’ confidence in their earnings forecasts and

stock valuation judgments was affected by the interaction of the similarity and

management approaches. As long as external segments were the same as internal

segments, analysts’ confidence was not affected by whether products combined in a

segment were similar or dissimilar. In contrast, if external and internal segments

differed, analysts had greater confidence in their judgments when similar products

were combined in a segment than when dissimilar products were combined. These

results support the FASB’s position that the management approach will positively

affect analysts’ perceptions of the reliability of segment data. The authors further

insists that their results suggest that, in certain cases, the management approach will

enhance analysts’ confidence in reported segment data.

Don Herrmann and Wayne Thomas (1996) in their article titled, “Segment

Reporting in the European Union: Analysing the effects of Country, Size, Industry,

and Exchange Listing”, provides an analysis of segment reporting practices of

Companies in the European Union and to identifies factors which potentially

influence the quality of disclosure. The quality of segment reporting is defined as the

number of financial statement items (e.g., sales, profits, assets) disclosed per segment.

Segment reporting by line of business and by geographic area are analysed separately.

The four variables hypothesised to influence the quality of segment reporting are

country, company size, industry and exchange listing. The multiple regression

analysis measures the marginal effect of each variable while holding the effects of all

other variables constant. The result indicate that the quality of segment reporting is

significantly affected by country, company size and exchange listing. No evidence is

found for an industry effect.


87

Stephen B Salter et.al., (1996) in their article titled, “Reporting Financial

Information by Segment : A Comment of the American Accounting Association on

the IASC Draft Statement of Principles”, summarises the views of the American

Accounting Association on the IASC’s initial proposed amendments to IAS 14,

Reporting Financial Information by Segment. The authors found that extant academic

literature views current IAS and US rules on geographic segment disclosure,

relatively ineffective. The report analyses the two proposed solutions for designing

segments, the risk and return approach (advocated by IASC) and the Management

approach (of the FASB). The authors found it in favour of the former. The report

makes specific recommendations for tightening of thresholds for reporting and

simplification of segment disclosure requirements.

Dave Nichols et.al., (1995) in their article titled, “Earnings Forecast Accuracy

and Geographic Segment Disclosures”, say that Statement of Financial Accounting

Standards (SFAS) No. 14 requires US Companies with significant foreign operations

to disaggregate certain disclosures into geographic segments. The study investigates

whether or not financial analysts’ earnings forecasts for multinational Companies

improved after SFAS 14. The results indicate that after adjustment for differences in

earnings variability, financial analysts’ forecasts of the earnings of multinational

Companies did become significantly more accurate (relative to that of a group of

control Companies) after the disclosure of geographic segment information.

Gary J Kelly (1994) in their article titled, “Unregulated Segment Reporting :

Australian Evidence”, say that segment performance disclosures analysed in

conjunction with consolidated financial information, enhance investment and credit

decision analysis. Given the benefits of a finer (disaggregated) information set, the

authors address the need to investigate and model the cost aspects associated with

unregulated segment reporting. More specifically, the study provides empirical

evidence about the structure of proprietary costs and agency costs arising from

discretionary segment disclosures and non-disclosures. It is hypothesized that

proprietary costs associated with disclosure and agency costs arising from non-

disclosure are related to the reporting decision of a multi-segment corporation’s

management. Specifically, the results show a positive correlation between return on

investment (ROI) and voluntary segment disclosure which may be the result of


88

proprietary cost considerations. These findings have important policy implications

regarding the formulation and subsequent refinement of accounting standards.

Nasrollah Ahadiat (1993) in his article titled, “Geographic Segment

Disclosure and the Predictive Ability of the Earnings Data” say that the Standards of

segment reporting disclosure of the enterprise’s foreign operations by geographic area

[FASB 1976, Statement No.14] is believed to be useful in predicting the future

prospects of the enterprise as a whole. In his paper, he examines the predictive value

of geographic earnings vis-à-vis consolidated earnings figures. Time-series

methodology is used for this analysis. Forecasting models were developed for both

segmental and consolidated income series. To test the predictive ability of each set of

data, earnings forecasts were made. Bothe the enterprise’s segmental and consolidated

models were used for these predictions. The result indicate that, although consolidated

income series provide a reasonably adequate forecast of income, geographically

segmented earnings improve the accuracy of predictions. Further, the findings suggest

that the predictive ability of foreign earning is slightly improved (in eleven out of

fifteen cases) with more data disaggregation.

Daisun Lee (1987) in his article titled, “Information Content and Economic

Consequences of Interim Segment Reporting: An Empirical Test” say that the

Securities Exchange Commission proposed, but has not adopted a regulation to

require the listed companies to disclose a segment information in Form 10-Q filings to

enhance the usefulness of Management’s Discussion and Analysis. The author’s main

purpose was to examine interim segment reporting’s’ market consequences that may

be useful to the accounting profession in understanding the issues relevant to that

reporting practice. In a multi-period setting, an earnings announcement functions as a

source of both predictive and confirmatory information. Therefore, an increase in

market reactions around earnings announcement caused by predictive value may be

totally offset by a decrease associated with confirmatory information. However, the

ongoing shift can be observable if the magnitude of increase in market reactions

associated with the first use of interim segment information is more than that

associated with predictive value of each subsequent earnings announcement. In his

study, the author compares market reactions measured by standard deviation of the

market model residual around earnings announcements for consecutive four paired


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quarters distinguished by disclosure of interim segment information. Reduction in

market reactions is observed only around the second quarter earnings announcement;

thus, it provides partial evidence of the ongoing shift. This ongoing shift can be fully

supported if the corresponding increase in market reactions is detected at some point

early in the transition period. The author further states that because interim segment

information represents a finer set of information, its economic consequence is

examined in terms of changes in Companies’ costs of capital, as measured by their

respective Beta values. Although disclosure of interim segment information is

associated with changes in Beta values of reporting Companies, no statistical

conclusion can be made as to the direction of change in their respective costs of

capital.

David L Sayers (1985) in the article titled, “The Impact of Segment

Reporting on Analysts’ Earnings Forecasts: The case of FASB Statement No. 14” say

that in 1969 and 1970, the Securities and Exchange Commission adopted rules

mandating the disclosure of segment revenues and profits. Empirical tests of the

usefulness of segment data have yielded mixed results. Capital market studies of

segment disclosures have been inconclusive. Earnings forecast studies seem to be the

most promising means of examining the usefulness of segment data. In 1976, the

Financial Accounting Standards Board issued Statement No. 14 which required

extensive segment disclosures in the annual reports of publicly-owned companies. His

study examines the impact of FASB 14 segment disclosures on security analysts’

earnings forecasts. The earnings forecasts used in his study are the composite

forecasts published by the Institutional Brokers Estimate Service (IBES). Actual

earnings figures were taken from IBES and from the annual reports of sample

Companies. A measure of forecast accuracy was computed for two groups of

Companies for the period 1976-1979. The multi-segment treatment group consisted of

Companies that disclosed segment revenues and profits for the first time after FASB

14 became effective. The single-segment control group consisted of Companies that

reported only consolidated earnings for the entire test period.

Regression Analysis was used to analyze changes in forecast accuracy during

the test period. The independent variables were “reporting method” and “economic

conditions”. After controlling for multi co-linearity between the independent


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variables, the results supported the hypothesis that earnings forecasts did improve for

the single-segment control group. The primary conclusion is that there was a

significant association between improved earnings forecasts and the disclosure of

FASB 14 segment data. Because forecasts did not improve for the control group, this

association cannot be attributed only to overall improvements in forecasting

techniques.


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CHAPTER IV REVIEW OF LITERATURE - Shodhgangashodhganga.inflibnet.ac.in/bitstream/10603/37267/6/...Examination of Financial Reporting Fraud at the Segment Level ˛ studied to assess