Query No. 13

 

Subject:           

Segment  Reporting.1

 

A.  Facts  of  the  Case

 

1.  A listed company is engaged in the business of exploration, exploitation and production of hydrocarbons which is segregated between crude oil and natural gas.

 

2.  The following activities are involved in achieving the object of exploration, exploitation and production of hydrocarbons:

 

(a)   Survey

 

(b)   Exploration

 

(c)   Development

 

(d)   Production

 

(e)  Transportation

 

3.  The main products of the company are crude oil and natural gas.  The natural gas is further fractionated into value added products like LPG, naphtha, ethane/propane, aromatic rich naphtha, and superior kerosene oil.

 

4.  The customers of the company are mainly PSU refineries.  According to the querist, the company has been realising its dues from the refineries as per the terms and conditions of the contract and as such there has been no financial risk as far as the debtors of the company are concerned.

 

5. According  to  the  querist,  since  the  company  is  engaged  only  in exploration and exploitation of hydrocarbons and does not have a diversified portfolio as such, the provisions of Accounting Standard (AS) 17, ‘Segment Reporting’, issued by the Institute of Chartered Accountants of India, may not be applicable.

 

6.  As per the querist, the statistics of some of the international exploration and production companies gathered from their financial results, reveal that exploration and production has been identified as one business segment and different countries have been identified as different geographical segments. As per the querist, since the company is involved in upstream activity, i.e., exploration and exploitation of hydrocarbons, the same may amount to a single business segment, i.e., exploration and production.  To support this contention, the querist has referred to a Guide to AS 17, issued by a firm of chartered accountants, for general information, wherein while citing examples of business segments across different industries, an example of exploration company has also been cited.

 

7. Irrespective  of what  is  stated by the querist  in paragraphs 5  and  6 above, the querist has informed that while publishing the 3rd quarter financial results for the quarter ended 31.12.2001, the company has published the segment-wise revenue, results and capital employed based on the following segments on the basis of, as stated by the querist, different risks and returns involved as well as the organisational structure:  

(a)   Offshore  

(b)  Onshore  

(c)  Joint Ventures  

(d)  Unallocated

 

The above are explained in the subsequent paragraphs.

 

8. The company’s operations are located primarily offshore and onshore,in different parts of the country, i.e., eastern, southern and western. The operational areas onshore and offshore are as follows:

 

Onshore

 

(i)  Eastern onshore includes Upper Assam, Silchar, Dhansiri Valley Project, Jorhat, Agartala, Geo Science Division (Jorhat), Central Workshop (Sibsagar) and Transportation and Shipping (Kolkata). Out of the above, Upper Assam, Silchar, Dhansiri Valley Project, Jorhat and Agartala, are the producing units and the rest are the support service providers.  

(ii)  Southern onshore includes Krishna Godavari onshore, Cauveryand Regional office, Chennai.  

(iii)  Western onshore includes Ahmedabad, Ankleswar, Mehsana, Jodhpur, Cambay, Central workshop, Baroda and Regional office, Baroda.

  Offshore  

(i)   Mumbai offshore

(ii)   Neelam and Heera Bassin & Satellite fields

(iii)   Hazira

(iv)  Uran

(v)  Krishna Godavari Offshore

 

Joint  Ventures

 

  In addition to the above, the company has entered into production sharing contracts in respect of certain properties with the Government of India and some corporate bodies, viz., Panna Mukta Tapti Joint Venture, Ravva Joint Venture, Pondicherry Joint Venture and Blocks under New Exlploration Licensing Policy.

 

  Unallocated

 

The company has certain units located at different parts of the country which are mainly training/research institutes and support service providers.  These units are as under:  

(i)   West Bengal Project

(ii)   Geo Science division, Kolkata

(iii)  Geo Science Division, Dehradun

(iv)   Excom, New Delhi

(v)    Jammu Project

(vi)   Research/Training institutes like IRS Ahmedabad, IDT Dehradun, IPE (including IMD and GEOPIC) Dehradun, IMBIGS Jorhat, IPSEM Goa, IOGPT Mumbai, IEOT Mumbai.

(vii)   Head Quarters, Dehradun

(viii)  Registered office, New Delhi.

 

9.  The querist has referred to the definition of the term ‘geographical segment’, as contained in AS17, which is reproduced below:

 

“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.   Factors that should be considered in  identifying  geographical  segments  include:

 

(a)   similarity of economic and political conditions;  

(b)   relationships between operations in different geographical areas;  

(c)   proximity of operations;  

(d)   special risks associated with operations in a particular area;  

(e)   exchange  control regulations;  and  

(f)   the  underlying currency  risks.”  

The querist has provided the following information with respect to the above factors:  

(a)  Similarity of economic/political conditions  

As per the querist, since the company is operating within the Indian territory, the economic and political conditions are similar.  

(b)  Relationship between operations in different geographical areas  

As per the querist, all the units as referred to above are independent accounting units and prepare their own balance sheets and profit and loss accounts and, hence, there is no direct relationship among the units with relation to operations.

 

(c)   Proximity of operations

As per the querist, the operational units are not in proximity to each other, such as operational units of eastern region are not in proximity to southern and/or western region or even to offshore areas.  

(d)  Special risks associated with operations

 

As per the querist, as brought out above, the company is carrying out its operations broadly onshore and offshore, the equipments and technology used for carrying out the operations of the company are different but the processes are the same. No rma l l y, i n t h e c a s e o f on s h o re o p er a t i on s th e r is ks associated with all the operations are the same. Whereas the general risk is the same in exploration and production business, there are special risks associated with the operations in offshore since operations are carried out in mid-sea.  

(e)&(f) Ex change control regulations and the underlying currency risks 

As per the querist, exchange control and underlying currency risks are similar in all areas pertaining to the company.

 

10. The querist has referred to paragraph 10 of AS 17 which, inter alia, provides that the organisational and internal reporting structure of an enterprise will normally provide evidence of whether its dominant source of geographical risks results from the location of its assets (the origin of its sales) or the location of its customers (the destination of its sales).

 

11.   As per the querist, in the case of the company, the internal reporting system  is  based  on  onshore  and  offshore.   Since  the  company’s  entire production of crude oil and gas and value added products are derived from one single source, i.e., hydrocarbons, geographical segments based on the concept of offshore and onshore operations spread over different regions appears to be appropriate.  As per the querist, the Board of Directors has agreed in principle that pending the opinion of the Institute of Chartered Accountants of India, geographical segments as mentioned above be identified as  primary  segments  and  business  segment  as  the  secondary  segment. Accordingly, the financial results of the quarter ended 31.12.2001 have been prepared and published.

 

B . Query

 

12.  The querist has sought the opinion of the Expert Advisory Committee regarding the applicability of AS 17, on the basis of the facts explained above.

 

C.  Points  considered  by  the  Committee

 

13. The Committee notes the definition of the term ‘business segment ’ contained in paragraph 5 of AS 17, which is reproduced below:

 

“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  busines s segments.  Factors  that  should  be  considered  in  determinin g whether products  or services  are  related include:

 

(a)    the nature of the products or services;

(b)    the nature of the production processes;

(c)    the type or class of customers for the products or services;

(d )    the methods used to distribute the products or provide the  services;  and

(e)     if applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.”

 

14.  The Committee notes from the facts of the case that the company is engaged  in  the  business  of  exploration,  exploitation  and  production  of hydrocarbons  which are segregated into  crude oil and  natural  gas.   The Committee further notes that natural gas is further fractionated into value added products like LPG, naphtha, ethane, propane, aromatic rich naphtha and superior kerosene oil.  It is, however, not clear whether the company in question undertakes the fractionating process or the same are performed by other entities, e.g., refineries.  From paragraph 1 of the facts of the case, it appears that the company only produces hydrocarbons, viz., crude oil and natural gas.  The Committee notes that the querist has not described whether crude oil and natural gas are related in terms of the factors contained in the definition  of  the  term  ‘business  segment’  as  reproduced  in  the  above paragraph. The Committee, however, notes, keeping in view the facts of the case,  that the  management  of  the  company  considers  that  crude oil  and natural gas are related products and, consequently, constitute single business segment.  The Committee is of the view that if these products are related as per the factors contained in the definition of ‘business segment’, it would be proper not to consider these products as separate segments.

 

15. The Committee notes the definition of the term ‘geographical segment’ contained in paragraph 5 of AS 17 which is reproduced by the querist in paragraph 9 above.

 

16. The Committee also notes paragraphs 8 and 9 of AS 17 which state as below:  

“8.  Similarly, a single geographical segment does not include operations in economic environments with significantly differing risks and returns. A geographical segment may be a single country, a group of two or more countries, or a region within a country.”

“9.  The risks and returns of an enterprise are influenced both by the geographical location of its operations (where its products are produced or where its service rendering activities are based) and also by the location of its customers (where its products are sold or services are rendered).  The definition allows geographical segments to be based on either:

(a)   the location of production or service facilities and other assets of an enterprise; or

(b)   the location of its customers.”

17.  The Committee notes from the facts of the case that the operations of the company are located primarily offshore and onshore across different parts of the country.  The Committee further notes that the company also has few units located at different parts of the country which are mainly training/research institutes and support service providers.  The Committee also  notes  that  the  querist  has  explained  that  ‘onshore’  and  ‘offshore’ constitute separate geographical segments since their risks and returns differ and also because they are so recognised by the company’s organisational structure and internal reporting system.  While the Committee does not wish to comment on the nature of the explanations given by the querist in paragraph 9 above, it notes the assertions of the management regarding differing risks and  returns  of  ‘offshore’  and  ‘onshore’  segments.   The  Committee  is, accordingly, of the view that since, as per the querist, the risks and returns of the aforesaid segments are different within the meaning of the definition of the term ‘geographical segment’, the aforesaid can be considered as separate geographical segments. If it were so, apparently, these geographical segments would be based on location of their assets.  The aforesaid segments should be considered as ‘Reportable Segments’ if they meet the threshold criteria laid down in paragraphs 27 and 29 of AS 17. However, the management has a discretion to report on any segment even if it does not fulfill the criteria laid down in paragraph 27. In this context, the Committee notes that the company has considered ‘onshore’ and ‘offshore’ as reportable segments in their 3rd quarter unaudited financial results for the quarter ending 31.12.2001.

 

18.  The Committee is of the view that it is not correct to categorize ‘Joint Ventures’ as a separate ‘geographical segment’ since it neither signifies a region within a country or a country itself.  Joint ventures should first be accounted for in accordance with Accounting Standard (AS) 27, ‘Financial Reporting of Interests in Joint Ventures’, and should form part of the business and/or geographical segment to which the joint ventures relate. For instance, information relating to an offshore joint venture should be reported under offshore segment as per AS 27.

 

19.  The Committee is further of the view that it would be incorrect to label ‘unallocated’ as a separate segment, since it represents the residuary head, i.e., the head which contains revenue, assets and liabilities which cannot be allocated to different segments.

 

20.  The Committee notes paragraphs 19, 20 and 21 of AS 17 which state as below:

 

“ 19 .   The dominant source and nature of risks and returns of an enterprise should govern whether its primary segment reporting format will be business segments or geographical segments.   If the risks and returns of an enterprise are affected predominantly by differences in the products and services it produces, its primary format for reporting segment information should be busines s segments, with secondary information reported geographically. Similarly, if the risks and returns of the enterprise are affected predominantly by the fact that it operates in different countries or other geographical areas, its primary format for reporting segment information should be geographical segments, with secondar y information reported for groups of related products and services.”

 

“ 2 0 . Internal  organisation  and  management  structure  of  a n enterprise and its system of internal financial reporting to the board of directors and the chief executive officer should normally be the basis for identifying the predominant source and nature of risks and differing rates of return facing the enterprise and, therefore, for determining which reporting format is primary and which is secondary, except as provided in sub-paragraphs (a) and (b) below:  

 

(a)   if risks and returns of an enterprise are strongly affected both by differences in the products and services it produces and by differences in the geographical areas in which it operates, as evidenced by a ‘matrix approach’ to managing the company and to reporting internally to the board of directors and the chief executive officer, then the enterprise should use business segments as its primary segment reporting  format  and  geographical  segments  as  its secondary  reporting  format;  and

 

(b)  if internal organisational and management structure of an enterprise and its system of internal financial reporting to the board of directors and the chief executive officer are based neither on individual products or services or groups of related products/services nor on geographical areas,  the  directors  and  management  of the  enterprise should determine whether the risks and returns of the enterprise are related more to the products and services it produces or to the geographical areas in which  it operates  and should,  accordingly,  choose  business segments  or  geographical  segments  as  the  primary segment reporting format of the enterprise, with the other as  its  secondary reporting  format.”

 

"" 21.For most enterprises, the predominant source of risks and returns determines how the enterprise is organised and managed. Organisational and management structure of an enterprise and its internal financial reporting system normally provide the best evidence of the predominant source of risks and returns of the enterprise for the purpose of its segment reporting. Therefore, except in rare circumstances, an enterprise will report segment information in its financial statements on the same basis as it reports internally to top management. Its predominant source of risks and returns becomes its primary segment reporting format.  Its secondary source of risks and returns becomes its secondary segment reporting format.”

 

21. The Committee notes from the facts of the case that the company has identified geographical segments as primary segment reporting format and business segment as the secondary segment reporting format. The Committee is of the view that if the determination of primary segment format is based on factors mentioned in paragraphs 19, 20 and 21 of AS 17, as reproduced above, geographical segment should be considered as the primary reporting format. With regard to business segment as the secondary reporting format, the Committee is of the view that if the company considers, as in the present case, that there is only one business segment, it is not necessary to provide secondary segment reporting information as per AS 17 since paragraph 19 uses the expression ‘secondary segments’, i.e., it stipulates more than one secondary segment.  In this context, the Committee also notes the General Clarification (GC) – 11/2002, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India, on AS 17, which states that “Accounting  Standard  (AS)  17,  Segment  Reporting,  defines  ‘business segment’ and ‘geographical segment’. It is clarified that in case, by applying these definitions, it is concluded that there is neither more than one business segment nor more than one geographical segment, segment information as per AS 17 is not required to be disclosed.”

 

D.   Opinion

 

22.On the  basis of and subject  to stipulations  dealt with  in the  above paragraphs, the Committee is of the following opinion:  

(a)  Crude oil and natural gas can be considered as one business segment since as per the querist the risks and returns in respect of these products are the same.  

(b)   Offshore and onshore can be considered as geographical segments, as risks and returns are different in respect of these segments as per the querist.  ‘Joint ventures’ is not a geographical segment ; these should be accounted for as discussed in paragraph 18 above.  

(c)   Primary segment reporting format can be the geographical segments. It is not necessary to provide information in respect of secondary segment reporting format for a business segment if it is considered that there is only one business segment.