Last week, along with its weak quarterly results, Hindustan Unilever Ltd (HUL) announced a separation of its ice cream business, kindled a curiosity to check its numbers in the company’s annual report.
It would have been a shock if the ice cream business, constituting a 3% turnover of the company, figured as a separate segment. And it didn’t!
Another company that recently announced a separation of its business due to a global reorganisation is SKF, a leader in the business of ball and roller bearings.
Globally, SKF is separating the ‘industrial’ and the ‘automotive’ segments of the bearings business and the Indian board has announced a similar separation.
A visit to the annual report of SKF to understand the contours of the two businesses under discussion met with a pious declaration that the chief operating decision maker (CODM) viewed all parts of the company as a single business.
What exactly is this concept of segment reporting and why is it important and how do some of the leading companies fare in this regard in India is the crux of this paper.
While less common in mature markets like the US, in India, a cement company branching into a fertiliser business or a cigarette manufacturer setting up hotels is par for the course due to the benefits of tax setoff for the losses arising in a new business against the profits of an established one.
Funding a new business with the ability to borrow on the collateral of an existing business that is profitable has helped Indian promoters to manage growth without additional equity commitments.
In the US, the concept of reporting results based on business segments started in 1997. Ten years later, India followed suit with accounting standard No17 (later replaced with standard 108).
There is little literature in the public domain in India on how well compliance has been achieved. No study conducted by an independent organisation in this matter could be sighted.
Even in the US, there is heartburn on the level of compliance. The US Securities and Exchange Commission (SEC) has been pulling up companies that do not provide adequate segment information in the filings but narrate a different story in corporate presentations, and investor calls.
Technology giants like Google, Amazon, and the like have been noticed to avoid proper disclosures of segment information. These are under the regulatory radar for very many things they do.
Unlike here, a good deal of discussion and research is noticed there on this subject. One such is a survey by CFA Institute Research and Policy Center published in 2018. Some of its findings are used in this article.
The decision on what constitutes a reportable segment is left to the management of the company (CODM).
A chart provided by the financial accounting standards board (FASB) on how logically a segment should be identified is shown here.
The major choke point is the second step that blocks the segmentation based on the CODM’s discretion.
Even if an operation is independent, with separate financials, it is not reported as a segment if the CODM affirms that she evaluates the results of the same only within a larger set of operations!
The chart on the left is one of the questions in the CFA survey about whether CODM's decision on the segment selection is correct.
Only 16.7 respondents strongly agreed with the present situation, implying that this approach is not wholly satisfactory.
Another aspect that overhangs this subject is the fear that too much disclosure will lead to a competitive disadvantage. This fear is universal and is louder in the Indian boardrooms!
In the glorious past, when market data was scarce, companies would have arrangements with excise officials to get the data on their competitors, as the RT12 was a goldmine of information.
Nowadays, such information and data have become scarce with the goods and services tax network (GSTN). Even the government is uncomfortable releasing industry or sector-wise data.
In the CFA survey, many respondents disagreed that competitive risk is a valid basis for withholding information.
Rather than just theorising the matter, some spicy examples in the Indian context may make the discussion a little more sparkling like the ensuing Deepavali celebrations!
The first example is an interesting one where the company, from the inception of AS17 in FY06-07 till FY17-18 adopted the position that the manufacture of commercial vehicles of various types, the manufacture of passenger cars, the financing business that aided the purchase of the vehicles and a few miscellaneous services constituted a single segment!
The figure in green is the capital employed (in rupees crore) and the one in blue is the ‘earnings before other income, finance cost, foreign exchange gain/ (loss) (net), exceptional items and tax’. The above figures pertain to FY17-18.
The company had a sudden change of heart in FY18-19 and presented, what hitherto was a single segment under four different segments. The portion shaded in orange may be read to appreciate the reasons for the change of heart!
The split numbers of the capital employed (green) and the earnings ………. (blue) tell a story far different than the amorphous information given to the shareholders for a full 12-year period.
Of course, neither did the regulator question the past conduct nor did the investors take umbrage at such an attitude towards them.
The next one is a conglomerate ‘khichadi’ that is into a mind-boggling array of sectors.
Since some of its subsidiaries and associates are themselves listed, the availability of data from public sources on those businesses neutralises the poor segment reporting in the consolidated numbers.
The definition of the automobile business is expansive to cover all vehicles with wheels! Four, three and two!
An escape chute available in the standard is the 10% threshold for assets or revenue for qualifying as a reportable segment.
In the above case, the threshold for the assets would be Rs21,100 crore. For revenue, it is Rs13,900 crore. It should be noted that there are less than 200 companies in India with a turnover exceeding Rs13,900 crore.
While a de minimis approach is necessary to give relief to small companies from incurring undue compliance cost, large companies with the latest IT architecture have no excuse to use that threshold.
One of the survey questions was on the availability of technology that can easily help management to compile the information necessary to be disclosed than take shelter under exclusions.
To round off the examples in the auto industry, the disclosure of another veteran player is shown below.
A piece of important and inspiring information for the investors is that the company has a single management reporting system to encompass defence and armoured vehicles; all types of luggage carriers like lorries and trucks; buses, supplied both to state bus undertakings and for private use; DG sets used in homes and offices; and forged parts and components used in automobiles!
And cheekily avers that the risks and returns are similar across these diverse products!
God save the company if the business is actually run this way!
Entering the domain of consumer products, commonly FMCG, a great deal of arbitrariness is seen in defining the segment. It will be no surprise if they toss the coin and decide.
A colourful case is exhibited below.
HIT should be sprayed on all those who decided that a cockroach killer and the hair colour shampoo used by Bollywood stars should fall under a single reporting segment!
An escape route that companies like Godrej resort to is to give the geographical segment fairly inane and useless and avoid giving business segments.
The CFA survey results overwhelmingly show that the investors’ question is primarily about the product segment.
Another specimen decides the segment depending on whether a product is branded or unbranded!
Expect a segment report soon based on whether a product is endorsed by a cricketer or a film star!
The regulator or the government wielding the stick is a common modus to get the companies to behave.
Lo and behold! There is an example in this category as well!
Another question that the survey considered was permitting companies to aggregate multiple operating segments into a single reporting segment.
Though 57% of the respondents did not disagree with aggregation, they sought additional information.
The last example is a unique case of not recognising any duality or parts but seeing everything as one. The CODM sees no distinction between a hero and a sparrow!
Treating infant milk powder and pet food as indistinguishable is either the equivalent of Advaitic apathy to existence or a nonchalant way of saying, ‘to hell with segment reporting’!
The parent, Nestlé SA, in Switzerland, is cut no slack in this respect.
It publishes its result as per the extract shown here. The full data of operating profits, assets and liabilities are shown for each of these verticals.
The local entity has business heads aligned with the segments adopted by the parent. Their reporting and evaluation of the business performance would likely be at the regional level, such as segmentation.
Why, then, is the segment data not available to the investors and readers of the annual report?
The local auditor, who accommodates this egregious agglomeration of all products under a single segment for the Indian reporting, must actually feed the segment details to its Swiss counterpart to aggregate the data country-wise.
Another question in the survey was the responsibility of the auditors to question the segment selection.
The results offer no surprise, and a significant number of responses indicated that the auditors should consider this a critical or key audit issue.
Readers may respond to how many audit reports show segment reporting as a (key account management) KAM!
A simple solution to getting some sanity in segment reporting is at the minimum treat products that fall under distinct chapters in the harmonised system of nomenclature (HSN) code, or its equivalent in India, as separate segments.
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)
