In our previous blog, we covered the basics of AS 17 Segment Reporting — what it is, who must follow it, and the three-step process involved. In this blog, we go one step deeper and focus specifically on how to identify business segments and geographical segments, which is the very first and most important step under AS 17.
Getting this step right is critical. If you identify your segments incorrectly, everything that follows — the reportable segment tests, the disclosures, the reconciliation — will also go wrong. So let us understand this topic thoroughly with definitions, factors, and real examples.
Why Identifying Segments Correctly Matters
AS 17 requires every enterprise to first decide what kind of segments it operates in before anything else. The reason is simple — different parts of a business carry different risks and earn different returns. A company selling medicines and running hotels cannot treat both as one segment just because they belong to the same group.
The standard recognises two types of segments:
- Business segments — based on products and services
- Geographical segments — based on economic environment and location
The dominant source of risks and returns in the enterprise decides which of these two becomes the primary reporting format and which becomes secondary.
What is a Business Segment?
A business segment is a distinguishable component of an enterprise that is engaged in providing an individual product or 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 key phrase here is "different risks and returns." Just because two products are made by the same company does not make them one business segment. The risks associated with producing and selling them must be similar for them to be grouped together.
Factors to Identify a Business Segment
AS 17 lists the following factors to consider when determining whether products or services belong to the same business segment:
- The nature of the products or services
- The nature of the production processes
- The type or class of customers for the products or services
- The methods used to distribute the products or provide the services
- The nature of the regulatory environment, for example banking, insurance, or public utilities
An important rule is that a single business segment does not include products and services with significantly differing risks and returns. While there may be some dissimilarities across one or two factors, the products included in a single business segment are expected to be similar with respect to a majority of the factors listed above.
What is a Geographical Segment?
A geographical segment is a distinguishable component of an enterprise that is engaged in providing products or services within a particular economic environment and that is subject to risks and returns that are different from those of components operating in other economic environments.
In simple terms, if your company operates in two different countries or regions, and those regions have very different economic conditions, regulations, or currency risks, they qualify as separate geographical segments.
Factors to Identify a Geographical Segment
AS 17 lists the following factors to consider when identifying geographical segments:
- Similarity of economic and political conditions
- Relationships between operations in different geographical areas
- Proximity of operations
- Special risks associated with operations in a particular area
- Exchange control regulations
- The underlying currency risks
A geographical segment may be a single country, a group of two or more countries, or even a region within a single country. This is an important point that many students miss — geographical segments do not have to cross international borders.
Can a Geographical Segment Exist Within the Same Country?
Yes, absolutely. AS 17 clearly recognises that a geographical segment can be a region within a country. The test is not whether the operations are in different countries but whether they operate in economic environments with significantly differing risks and returns.
Example: Rural and Urban Markets in India
Company A manufactures and sells products only within India. However, its management information system is organised by two broad market segments — rural and urban.
To determine whether these are separate geographical segments, management must evaluate whether the rural and urban markets function in environments with significantly differing risks and returns. Factors to consider include:
- Different pricing policies between rural and urban markets
- Different credit policies for rural and urban customers
- Different resource deployment strategies
- Different demand patterns and growth prospects
If these differences are significant, then Rural India and Urban India can each qualify as a separate geographical segment under AS 17, even though both are within the same country.
This requires judgement. The standard itself acknowledges that determining the composition of a geographical segment involves a certain amount of judgement by management.
How are Business and Geographical Segments Determined?
Generally, business segments and geographical segments are determined on the basis of internal financial reporting to the board of directors and the Chief Executive Officer. The organisational structure of an enterprise and its internal reporting system are normally the starting point.
However, if the internally reported segments do not satisfy the definitions given in AS 17, then the following approach should be taken:
If some internally reported segments meet the definition of a business segment or geographical segment but others do not, the standard should be applied only to those internal segments that do not meet the definitions.
For segments reported internally that do not satisfy the definitions, management should look to the next lower level of internal segmentation that reports information along product and service lines or geographical lines.
If such a lower-level segment meets the definition of a business segment or geographical segment, the criteria for identifying reportable segments should then be applied to that segment.
Primary and Secondary Segment Reporting Formats
Once you have identified your business segments and geographical segments, the next step is to decide which one becomes the primary reporting format.
The dominant source and nature of risks and returns of an enterprise governs this decision.
If the risks and returns of an enterprise are affected predominantly by differences in the products and services it produces, its primary format for segment reporting should be business segments, with secondary information reported geographically.
If the risks and returns are affected predominantly by the fact that it operates in different countries or geographical areas, its primary format should be geographical segments, with secondary information reported for groups of related products and services.
What Does Primary Format Mean?
The primary format requires more detailed disclosures. For each reportable segment under the primary format, an enterprise must disclose:
- Segment revenue from external customers and from inter-segment transactions
- Segment result
- Total carrying amount of segment assets
- Total amount of segment liabilities
- Total cost to acquire segment assets during the period
- Depreciation and amortisation in respect of segment assets
- Significant non-cash expenses other than depreciation
What Does Secondary Format Mean?
The secondary format requires limited disclosures. If business segments are primary, the secondary geographical disclosures include:
- Segment revenue from external customers by geographical area for each geographical area contributing 10% or more of enterprise revenue
- Total carrying amount of segment assets by geographical location for each area with 10% or more of total assets
- Total cost to acquire segment assets by geographical location for qualifying areas
Practical Example: Microtech Ltd.
Microtech Ltd. produces batteries for scooters, cars, trucks, and specialised batteries for invertors and UPS.
Even though the basic product in all cases is a battery, the risks and returns are driven by completely different factors. Automobile batteries are affected by government policy on vehicles, road conditions, and quality of automobiles. Batteries for invertors and UPS are affected by power supply conditions, standard of living, and electricity infrastructure.
Therefore, Microtech Ltd. has two business segments:
- Automobile Batteries (scooters, cars, trucks)
- Batteries for Invertors and UPS
This is a clean example of how similar-sounding products can belong to different business segments because their risk and return profiles are different.
Practical Example: Diversifiers Ltd.
Diversifiers Ltd. has three divisions — Forging Shop, Bright Bar, and Fitting. The Forging Shop sells to domestic customers, exports, and also sells to the Bright Bar division. The Bright Bar division sells to the Fitting division and exports to Rwanda. The Fitting division exports to Maldives.
In this case, the company has both business segments (the three divisions) and geographical segments (Home, Export by Forging Shop, Rwanda, Maldives).
The segmental report must show:
- Revenue broken down by each division with inter-segment eliminations
- Sales revenue broken down by geographical market — Home Sales, Export Sales by Forging Shop, Export to Rwanda, and Export to Maldives
This example shows how a single company can have multiple business segments and multiple geographical segments at the same time, and how both must be reported under AS 17 Segment Reporting.
Key Differences Between Business Segment and Geographical Segment
Business segment is based on the type of product or service offered and the risks associated with producing and selling that product or service.
Geographical segment is based on the economic environment — country, region, or area — where the enterprise operates or sells, and the risks associated with operating in that environment.
Business segment risks include regulatory environment, production process risks, customer type risks, and distribution method risks.
Geographical segment risks include currency risks, exchange control regulations, political and economic conditions, and proximity of operations.
Both types of segments must have risks and returns that are different from other segments of the same type to qualify as a separate segment under AS 17.
Frequently Asked Questions
Q1. What is the main basis for identifying business segments and geographical segments under AS 17?
The main basis is the internal financial reporting system of the enterprise — specifically, how financial information is reported to the board of directors and the CEO. If the internal segments satisfy the AS 17 definitions, they are used directly. If not, management looks at the next lower level of segmentation.
Q2. Can a company have both business segments and geographical segments at the same time?
Yes. Every company will have both. The question is which one becomes the primary reporting format and which becomes secondary. This is decided by which source — products or geography — is the dominant driver of risks and returns.
Q3. Is it possible for a geographical segment to be within the same country?
Yes. AS 17 clearly states that a geographical segment may be a region within a country. If rural and urban markets in India have significantly different risks and returns, they can be treated as separate geographical segments.
Q4. What is the difference between primary and secondary segment reporting formats?
The primary format requires full and detailed disclosures including segment revenue, segment result, segment assets, segment liabilities, depreciation, and non-cash expenses. The secondary format requires only limited disclosures — mainly segment revenue and segment assets for qualifying segments.
Q5. Can management use its own judgement in identifying geographical segments?
Yes. AS 17 acknowledges that determining the composition of a geographical segment involves a certain amount of judgement. Management must consider the relevance, reliability, and comparability of the segment information that will be reported, guided by the definitions in the standard.
Q6. What happens if internally reported segments do not match AS 17 definitions?
Management must look at the next lower level of internal segmentation and check whether those lower-level segments meet the definitions of a business segment or geographical segment. If they do, the reportable segment criteria are then applied to those lower-level segments.
Q7. Does AS 17 allow a single product to be split into two business segments?
Yes, if the risks and returns of different uses of the same product are significantly different. The Microtech Ltd. example shows this clearly — batteries for automobiles and batteries for invertors are the same basic product but belong to two different business segments because of their different risk profiles.
Conclusion
Identifying business segments and geographical segments correctly is the foundation of the entire AS 17 Segment Reporting process. If this step is done right, everything that follows — applying the 10% test, the 75% test, preparing the segmental report, and making disclosures — becomes much easier.
The key takeaway is that segmentation is driven by risks and returns, not by product type or location alone. Two products that look similar can belong to different business segments if their risks and returns are significantly different. Two regions within the same country can be separate geographical segments if they operate in significantly different economic environments.
