In our previous blogs we covered how to identify business segments and geographical segments, how to find reportable segments using the 10% materiality test and 75% overall test, how to calculate segment revenue, segment expense, segment assets, and segment liabilities, and how to prepare the primary segment reporting format and secondary segment reporting format.
In this final blog on AS 17 Segment Reporting we focus on three remaining but very important topics — inter segment transfer pricing, other disclosures required under accounting standard 17, and how changes in segment accounting policies must be handled and disclosed. These topics may seem smaller compared to the earlier ones but they are frequently tested in exams and are also critical for real world compliance.
What is Inter Segment Transfer Pricing?
When one segment of an enterprise sells goods or provides services to another segment of the same enterprise, this is called an inter segment transaction. The price at which this transfer happens is called the inter segment transfer price.
For example, if the Forging Shop division of a company sells raw material to the Bright Bar division of the same company, the price charged for that transfer is the inter segment transfer price. This price determines the segment revenue of the selling segment and the segment expense of the buying segment.
Under AS 17, the rule is clear and simple — inter segment transfer pricing must be measured on the basis that the enterprise actually used to price those transfers. In other words, whatever method the company uses internally to price inter segment transactions, that same method must be used for external segment report disclosures ICAI purposes.
Methods of Inter Segment Transfer Pricing
Accounting standard 17 does not mandate any specific method for inter segment transfer pricing. An enterprise is free to choose any method it considers appropriate. The commonly used methods are:
Cost Based Pricing — The transfer is priced at the cost of production of the selling segment. This is simple but does not give the selling segment any profit margin on internal sales.
Cost Plus Pricing — The transfer is priced at cost plus a fixed markup or margin. This gives the selling segment a reasonable profit on internal sales.
Market Price Based Pricing — The transfer is priced at the prevailing market price for similar goods or services. This is considered the most arm's length and commercially realistic method.
Below Cost Pricing — In some cases an enterprise may price inter segment transfers below cost for strategic reasons. This is also permitted under AS 17.
The key requirement under inter segment transactions India rules is not which method you choose but that you choose one method, apply it consistently, and disclose it clearly in the financial statements.
Disclosure of Inter Segment Transfer Pricing
Under AS 17 other disclosures requirements, the following must be disclosed in the financial statements regarding inter segment transfer pricing:
The basis of pricing inter segment transfers must be disclosed. This means the enterprise must state clearly whether it uses cost, cost plus margin, market price, or any other basis for pricing transfers between segments.
Any change in the basis of pricing inter segment transfers must also be disclosed. If the enterprise changes its inter segment transfer pricing method from one period to the next, this change must be reported along with an explanation of why the change was made.
This disclosure requirement is important because different pricing methods can significantly affect the reported segment revenue and segment result of individual segments, even though the overall enterprise profit remains the same.
Solved Example 1: Inter Segment Transfer Pricing Policy
A company has an inter segment transfer pricing policy of charging at cost less 10%. Market prices are generally 25% above cost. Is the policy adopted by the company correct under accounting standard 17?
Solution
Yes, the policy is correct. AS 17 requires that inter segment transfer pricing should be measured on the basis that the enterprise actually used to price those transfers. The basis of pricing and any change therein must be disclosed in the financial statements.
The enterprise can have its own policy for inter segment transactions India — the transfers may be priced at cost, below cost, or at market price. However whichever policy is followed must be:
- Applied consistently from period to period
- Disclosed clearly in the financial statements
In this case the policy of charging at cost less 10% is the method actually used by the enterprise. Therefore it is correct under AS 17. The fact that market prices are 25% above cost does not make this policy wrong — accounting standard 17 does not require market price to be used. It only requires disclosure and consistency.
What are Segment Accounting Policies?
Segment accounting policies are the accounting principles and methods used in preparing and presenting segment information. They include two layers:
The first layer is the same accounting policies used for the enterprise financial statements as a whole. Since segment information is a subset of the enterprise financial statements, the same fundamental policies apply.
The second layer consists of policies that relate specifically to segment reporting — such as how segments are identified, the method used for inter segment transfer pricing, and the basis for allocating revenues and expenses to segments.
Under AS 17 other disclosures, an enterprise must describe its segment accounting policies in the notes to the financial statements so that users can understand how the segment information has been prepared.
Changes in Segment Accounting Policies
This is an important topic both for real world application and for segment report disclosures exam questions. Sometimes an enterprise may change its segment accounting policies. Such changes can happen for various reasons — a change in business strategy, a restructuring, a new management approach, or simply a decision that a different method gives more useful information.
Under accounting standard 17, if a change in segment accounting policies has a material effect on segment information, the change must be disclosed. The disclosure must include:
- A description of the nature of the change
- The financial effect of the change if it is reasonably determinable
Types of Changes That Affect Segment Reporting
Some changes in accounting policies relate specifically to segment reporting and do not affect the aggregate enterprise financial statements. The two most common examples are:
Change in Identification of Segments — If an enterprise reorganises its business and as a result identifies different segments than before, this is a change that affects only the segment report disclosures ICAI and not the overall enterprise figures.
Change in Basis of Allocating Revenues and Expenses — If an enterprise changes the method it uses to allocate revenues and expenses to segments — for example from a turnover based allocation to a headcount based allocation — this will change the reported segment revenue and segment result of individual segments without changing the enterprise totals.
Both types of changes can have a significant impact on segment information. That is why AS 17 other disclosures requires them to be reported clearly so users can understand what has changed and how it affects their ability to compare segment information across periods.
Why Disclosure of Policy Changes Matters
Imagine a company that reports high profits for its manufacturing segment in year one. In year two the company changes the basis for allocating head office costs from turnover to headcount. This change reduces the manufacturing segment profit significantly — not because the segment performed worse but simply because more costs are now allocated to it.
Without proper disclosure of this change in segment accounting policies, users of the financial statements would wrongly conclude that the manufacturing segment deteriorated. With proper disclosure they understand that the change in allocation method explains the difference and can adjust their analysis accordingly.
This is exactly why accounting standard 17 insists on full and transparent disclosure of any material changes in segment accounting policies.
Composition Disclosure
Under AS 17 other disclosures requirements, an enterprise must also indicate:
The types of products and services included in each reported business segment. This helps users understand what activities and product lines each segment covers.
The composition of each reported geographical segment, both primary and secondary, if not otherwise disclosed in the financial statements. This helps users understand which countries or regions are included in each geographical segment.
These composition disclosures are important because segment names alone — like Segment A or the Asia Pacific segment — may not give users enough information about what the segment actually does or where it operates.
Solved Example 2: Diversifiers Ltd. — Disclosure of Inter Segment Sales
In the Diversifiers Ltd. example from our previous blog, the Forging Shop division sold goods worth ₹4,575 thousand to the Bright Bar division, and the Bright Bar division sold goods worth ₹45 thousand to the Fitting division.
These are inter segment transactions India that must be:
Included in the segment revenue of the selling division — Forging Shop reports ₹4,575 thousand as inter-segment revenue and Bright Bar reports ₹45 thousand as inter-segment revenue.
Eliminated in the consolidated reconciliation column — The total inter-segment sales of ₹4,620 thousand (4,575 + 45) are eliminated so that the consolidated external revenue of ₹6,795 thousand is correctly stated.
Disclosed along with the pricing basis — The financial statements must state the basis on which these inter-segment transfers were priced, whether at cost, market price, or another method.
This is a perfect example of how inter segment transfer pricing rules work in practice under AS 17 other disclosures requirements.
Solved Example 3: Change in Segment Identification
A company previously reported three segments — Domestic Manufacturing, Export Manufacturing, and Services. After a major restructuring, the company now organises itself into four segments — North India Operations, South India Operations, Export Operations, and Financial Services.
This is a change in identification of segments under segment accounting policies. Under accounting standard 17, the company must:
Disclose the nature of the change — explain that the segment structure has been reorganised from three product and geography based segments to four location and function based segments.
Disclose the financial effect — restate the previous period segment figures using the new segment structure so that users can compare year on year performance on a like for like basis. If it is impracticable to restate the previous period figures, this fact must be disclosed.
This ensures that the segment report disclosures ICAI remain transparent and comparable even when the segment structure changes.
Summary of All AS 17 Disclosure Requirements
Under accounting standard 17, an enterprise must make the following disclosures in its financial statements:
Primary Format Disclosures for each reportable segment:
- Segment revenue split between external and inter-segment
- Segment result
- Segment assets
- Segment liabilities
- Capital expenditure on segment assets
- Depreciation and amortisation on segment assets
- Significant non-cash expenses in segment result
Secondary Format Disclosures:
- Segment revenue from external customers by geographical area or business segment
- Segment assets by geographical location or business segment
- Capital expenditure by geographical location or business segment
Other Disclosures:
- Segment accounting policies including basis of inter segment transfer pricing
- Any change in segment accounting policies with nature and financial effect
- Composition of each reported business and geographical segment
- Reconciliation of segment figures to enterprise figures
Frequently Asked Questions
Q1. Is there a specific method of inter segment transfer pricing mandated by AS 17?
No. Accounting standard 17 does not mandate any specific method. The enterprise can use cost, cost plus margin, market price, or any other method it actually uses internally. However the chosen method must be disclosed and applied consistently.
Q2. What happens if an enterprise changes its inter segment transfer pricing method?
Any change in the basis of inter segment transfer pricing must be disclosed in the financial statements. The disclosure must explain what changed and ideally quantify the financial effect of the change on the segment revenue and segment result of affected segments.
Q3. Do changes in segment accounting policies affect the overall enterprise financial statements?
Not always. Some changes — like changes in segment identification or changes in the basis of allocating revenues and expenses — affect only the individual segment figures. The enterprise totals remain the same. That is why separate disclosure of these changes in segment report disclosures ICAI is so important.
Q4. What must be disclosed when a company reorganises its segments?
The company must disclose the nature of the reorganisation and its financial effect. Previous period comparative figures should be restated to reflect the new segment structure so users can make meaningful year on year comparisons.
Q5. Are inter segment transactions India eliminated in the final financial statements?
Yes. Inter-segment revenues and expenses are included in individual segment figures but eliminated in the reconciliation column when preparing the consolidated enterprise financial statements. This prevents double counting of revenues within the enterprise.
Q6. Can an enterprise use different segment accounting policies for different segments?
No. Segment accounting policies must be consistent across all segments and must follow the same accounting policies used for the enterprise financial statements as a whole. However additional segment information may be disclosed on a different basis if it is used internally and the basis is clearly described.
Q7. What is the difference between a change in segment accounting policies and a change in general accounting policies?
A change in general accounting policies affects the enterprise financial statements as a whole. A change in segment accounting policies — such as a change in how segments are identified or how costs are allocated — affects only the segment information and not the enterprise totals. Both types of changes require disclosure but through different mechanisms under Indian accounting standards.
Conclusion
Inter segment transfer pricing, segment accounting policies, and AS 17 other disclosures may seem like the smaller or finishing topics of accounting standard 17 but they are actually very important for ensuring that segment information is transparent, consistent, and comparable across periods.
The core message of this blog is simple. Whatever method you use for inter segment transfer pricing, disclose it. Whatever change you make to your segment accounting policies, disclose it with its financial effect. Whatever products and regions your segments cover, describe them clearly for users.
Together with the concepts covered in our earlier blogs — identifying business segments and geographical segments, finding reportable segments, calculating segment revenue and segment result, and preparing the primary segment reporting format — this blog completes your full understanding of AS 17 Segment Reporting.
