A. Facts of the Case
1. A public sector company (hereinafter referred to as ‘the company’) is engaged in refining of crude oil. The refined petroleum products sometimes undergo primary processing as well as secondary processing. The different variants of petroleum products from both the processes are stored together in their respective tanks. Thus, the company is in a process industry with single input and multiple outputs where, as per the querist, the multi-stage processed and single stage processed products have same market value as they are same class of products.
2. The company sells most of its products domestically and around 35% of the products are exported. The export is dominated by two main products, viz., fuel oil and Naphtha which are inevitable resultant products of crude oil processing. The querist has provided a process flow diagram of the crude refining for reference of the Committee (Refer to Annexure A). An issue has arisen during the course of audit as to whether export sale is to be considered as a separate segment as per Accounting Standard (AS) 17, ‘Segment Reporting’ or not.
3. A view has been expressed that the export sales may be a separate segment as per the provisions of AS 17, since the sales revenue from exports are more than 10% and as such, this segment is a reportable segment and accordingly, necessary disclosures are to be made in the annual accounts. The other view is that considering the standard requirement as explained hereinafter, the disclosure presently being given would suffice.
4. The company has been making the following disclosure regarding applicability of AS 17 in its annual accounts:
“The Company is engaged in refining crude oil, all activities of the Company revolve around this business and the operations are in India. As such there is no other reportable segment as defined by Accounting Standard 17 – Segment Reporting issued under the Companies (Accounting Standards) Rules, 2006.”
5. The querist has stated that the main business of the company is refining of crude oil which is a single input and multiple output process industry. The risks and returns of the products produced by the company are same whether sold domestically or exported. Further, the querist has stated that as the components of an enterprise that are required to be reported separately, have to first fall within the definition of the terms, business segment and geographical segment, an analysis of factors determining the business segment and geographical segment with specific reference to standard requirement have been provided by the querist as follows:
(a) Business Segment:
(i) The company produces petroleum products, viz., Liquid Petroleum Gas (LPG), Naphtha, Motor Spirit, High Speed Diesel, Fuel Oil, etc. which are sold domestically as well as exported. The nature of products sold in both the markets is same.
(ii) The production process is refining of crude oil only. There is no separate process involved for manufacture of products exported.
(iii) The customers for all the products produced are basically oil marketing companies, domestic or international. The company is mainly selling its products in domestic markets. However, export is inevitable as domestic demand for such products is lower.
(iv) The products are sold on Free on Board (FOB) basis and mode of transport for bulk movement is by ship for domestic as well as for export. For domestic market, in addition to movement by ship, it is also transported through pipelines and tank trucks.
(v) There is no regulatory environment as far as sale of products from refinery is concerned. It is free to sell the products domestically as well as internationally. All products except LPG and kerosene can be exported. LPG and kerosene are not exported by the company, as the full quantities produced by the company are absorbed by domestic market.
Considering the above facts, the risks and returns related to all products whether exported or sold in domestic market are same.
(b) Geographical Segment:
(i) The company exports its products only on FOB basis, and therefore, there is no effect on economic and political conditions prevailing in domestic as well as export market. The products exported other than those sold under term contract, are bought by oil majors or traders who in turn supply these products to the end users. The company does not have any foreign offices and does not operate in other countries. All sales are done in India on FOB sales basis.
(ii) The exports made by the company are on FOB basis and as such, the ownership of the product is transferred to the buyers at the load port in India. No special risks are associated.
(iii) The company does not have any production facilities or marketing installations/marketing network abroad. Accordingly, the economic and political environment prevailing in India only is having an impact on both exports as well as domestic sales. There are no special exchange control regulations, like, restrictions on repatriation of money to India, which are applicable in case of realisation of export sale proceeds.
(iv) The basis of fixation of pricing of the products for exports as well as domestic sales are similar as both the prices are determined with reference to the international prices in $ (US Dollar) terms. Hence, there are no separate underlying currency risks for both types of sales.
(v) Most of the payments are through Letter of Credit (LC) and LC is opened prior to shipment.
Considering the above facts, the risks and returns under both the economic environments, i.e., for domestic and export market are same.
6. The querist has stated that as the company is engaged in crude oil refining, determination of cost of production of individual products emanating from crude oil refining meant for export and domestic market is difficult as apportionment of cost is not possible and each method also has its own merits and demerits. Determination of segment expenses is not possible for both business and geographical segments as determination of cost of production of individual products or group of related products is not possible.
7. Further, the capital assets used for production of individual products are same irrespective of whether it is sold domestically or exported. Further, the majority of products produced and exported are inevitable in the process of production as domestic demand for such products is lower and therefore, these have to be necessarily exported. There are no separate segment assets earmarked for both business and geographical segments. The querist has further stated that in view of commonality of assets used for products exported, the cost of assets relating to export sale cannot be quantified. No separate profit and loss account is made for determining profit or loss on export of products. There are also no separate exclusive expenditures incurred for export.
B. Query
8. In this background, the querist has sought the opinion of the Expert Advisory Committee as to whether export sale is to be considered as a separate segment as per AS 17 or not and if so, the applicable disclosure requirements of AS 17.
C. Points considered by the Committee
9. The Committee notes that the basic issues raised in the query relate to whether ‘export sale’ can be considered as a separate segment as per the provisions of AS 17 and the disclosure requirements in case AS 17 is applicable. The Committee has, therefore, considered only these issues and has not examined any other issue that may arise from the Facts of the Case, such as, propriety of the querist’s statement regarding Government’s or other regulations in case of a petroleum refinery. At the outset, the Committee wishes to point out that as per the principles of AS 17, a ‘business segment’ is a distinguishable component of an enterprise that is engaged in providing product(s)/service(s) subject to different risks and returns. Accordingly, business segment can be identified only on the basis of risks and returns involved in various products/services being produced by the company rather than the difference in risks and returns of the products being sold in different markets (domestic/international). Thus, although ‘export sale’ can be a factor for identifying the business segment of different products/services but it cannot itself be a separate ‘business segment’. The Committee notes from the Facts of the Case that the querist has analysed the ‘export sale’ as business segment, which is not appropriate, as is clear from the above. Accordingly, the Committee does not find merit in considering the arguments of the querist in respect of ‘export sale’ as a business segment. Accordingly, the Committee has, hereinafter, considered the issue only from the angle of ‘geographical segments’.
10. The Committee is of the view that for identifying geographical segments, as per the provisions of AS 17, the management has to apply its judgement considering the specific facts and circumstances of the case while evaluating whether the risks and returns of various geographic regions of an enterprise are related or different. These risks and returns are influenced both by the geographic location of its operations and also by the location of its customers. The organisational structure of an enterprise and its internal reporting system are normally the basis for identifying the segments, subject to their fulfilling the criteria prescribed in the definition of ‘geographical segment’ reproduced as below. The Committee also notes the following paragraphs of AS 17:
“5.2 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.”
“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.
10. 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). Accordingly, an enterprise looks to this structure to determine whether its geographical segments should be based on the location of its assets or on the location of its customers.
11. Determining the composition of a business or geographical segment involves a certain amount of judgement. In making that judgement, enterprise management takes into account the objective of reporting financial information by segment as set forth in this Standard and the qualitative characteristics of financial statements as identified in the Framework for the Preparation and Presentation of Financial Statements issued by the Institute of Chartered Accountants of India. The qualitative characteristics include the relevance, reliability, and comparability over time of financial information that is reported about the different groups of products and services of an enterprise and about its operations in particular geographical areas, and the usefulness of that information for assessing the risks and returns of the enterprise as a whole.
12. The predominant sources of risks affect how most enterprises are organised and managed. Therefore, the organisational structure of an enterprise and its internal financial reporting system are normally the basis for identifying its segments.”
11. The Committee notes from the Facts of the Case that the querist has also analysed the factors for determining geographical segments in the case of the company (refer paragraph 5 above). From the said analysis, the Committee notes that although, the company does not have any production facilities or marketing installations/marketing network abroad, there can still be separate geographical segments in view of the following:
(i) The Committee notes that paragraph 8 of AS 17 provides that a geographical segment may be a single country, a group of two or more countries, or a region within a country. Accordingly, even though all the refineries of the company are located in India, these may be subject to different risks and returns due to proximity of operations between various geographical locations – domestic and international.
(ii) Further, the Committee is of the view that in the extant case, the company may be subject to different risks and returns due to difference in economic and political conditions prevailing in various countries, different credit policies for various customers belonging to a region, etc., although the company does not have any production facilities/marketing installations/network abroad. For instance, Britain, France and Germany, being members of the European Union, may have similar economic environment on the basis of the relevant factors stated above but not similar to those that exist in USA or Singapore. Accordingly, Britain, France and Germany may be considered as one segment and a similar evaluation shall be made for customers based in other countries.
(iii) For identifying the geographical segments, the company should also consider organisational and internal reporting structure of the enterprise. For example, where internal reporting system of the company provides information according to the geographical location of the customers it indicates that the company has more than one geographical segments.
(iv) The Committee notes that although the querist has stated that the basis of fixation of pricing of products for export and domestic sales is determined with reference to international prices in terms of dollars, but for identifying geographical segments, one should also consider the currency in which payment would be received against sales and whether that currency would give rise to different risks and returns rather than the formula based on which the price is determined.
12. From the above, the Committee is of the view that export sale is, thus, subject to different risks and returns from that of domestic sales due to economic and political conditions as well as currency risk and accordingly, there appears to exist atleast two geographical segments, viz., export sales and domestic sales. The Committee is further of the view that a judgement has to be made by the management while determining the geographical segments even within export sales as to whether these segments are subject to significantly differing risks and returns based on the above-mentioned discussion considering various factors and attaching appropriate weightage to different factors keeping in view its own facts and circumstances based on its past experience and any changes expected to take place. As per paragraph 11 of AS 17, the management while making this judgement, should also consider the objective of reporting financial information by segment as set out in AS 17 and the qualitative characteristics of financial statements, viz., relevance, reliability, comparability over time and understandability of the resulting information.
13. The Committee is also of the view that after the above evaluation, it should be considered as to whether such geographical segments should be reported under the primary segment reporting format or secondary segment reporting format (if any) of the company, which should be identified based on the dominant source and nature of risks and returns of the enterprise as per the requirements (paragraphs 19 to 23) of AS 17. The internal organisational and management structure of an enterprise and its system of internal reporting to the decision makers should again be considered for determining the dominant source and nature of risks and returns of the enterprise.
14. After such identification of primary and secondary segment reporting formats, the disclosures regarding various segments determined on the basis of above considerations should be made as per the requirements (paragraphs 38 to 59) of AS 17. As regards determination of segment assets, segment liabilities, segment expenses and segment revenue for disclosure purposes, the Committee notes paragraphs 13 and 14 of AS 17, as reproduced below:
“13. The definitions of segment revenue, segment expense, segment assets and segment liabilities include amounts of such items that are directly attributable to a segment and amounts of such items that can be allocated to a segment on a reasonable basis. An enterprise looks to its internal financial reporting system as the starting point for identifying those items that can be directly attributed, or reasonably allocated, to segments. There is thus a presumption that amounts that have been identified with segments for internal financial reporting purposes are directly attributable or reasonably allocable to segments for the purpose of measuring the segment revenue, segment expense, segment assets, and segment liabilities of reportable segment.
14. In some cases, however, a revenue, expense, asset or liability may have been allocated to segments for internal financial reporting purposes on a basis that is understood by enterprise management but that could be deemed arbitrary in the perception of external users of financial statements. Such an allocation would not constitute a reasonable basis under the definitions of segment revenue, segment expense, segment assets, and segment liabilities in the Standard. Conversely, an enterprise may choose not to allocate some item of revenue, expense, asset or liability for internal financial reporting purposes, even though a reasonable basis for doing so exists. Such an item is allocated pursuant to the definitions of segment revenue, segment expense, segment assets, and segment liabilities in the Standard.”
On the basis of the above, the Committee is of the view that the company should consider its internal financial reporting system as the starting point for identifying items that can be reasonably allocable to segments. However, if items have been allocated for internal financial reporting purposes on a basis that is understood by management but that can be deemed arbitrary in perception of external users, the same would not constitute a reasonable basis for the purpose of segment reporting as per AS 17. If, however, an item has not been allocated due to limitation of existing internal financial reporting system of the enterprise, the enterprise should develop an appropriate system, as non-availability of requisite information is not sufficient reason to classify an item as an unallocated reconciling item, if a reasonable basis for allocation can be arrived at.
15. As regards the basis of allocation, the Committee also notes paragraph 37 of AS 17, which provides as follows:
“37. The way in which asset, liability, revenue, and expense items are allocated to segments depends on such factors as the nature of those items, the activities conducted by the segment, and the relative autonomy of that segment. It is not possible or appropriate to specify a single basis of allocation that should be adopted by all enterprises; nor is it appropriate to force allocation of enterprise asset, liability, revenue, and expense items that relate jointly to two or more segments, if the only basis for making those allocations is arbitrary. At the same time, the definitions of segment revenue, segment expense, segment assets, and segment liabilities are interrelated, and the resulting allocations should be consistent. Therefore, jointly used assets and liabilities are allocated to segments if, and only if, their related revenues and expenses also are allocated to those segments. For example, an asset is included in segment assets if, and only if, the related depreciation or amortisation is included in segment expense.”
Accordingly, the Committee is of the view that in the extant case, the company should determine segment assets, segment liabilities, segment expenses and segment revenue for disclosure purposes on the basis of the above discussion. As regards, the querist’s assertion that no exclusive expenditure is incurred for export sales and apportionment of cost is not possible, the Committee is of the view that still the segment expense for export sales can be determined by reference to some suitable method, e.g., quantity of products sold in each geographic region and allocation of common overheads on a reasonable basis. On the basis of paragraph 37 of AS 17, the Committee is further of the view that if expenses and revenue related to common assets like utilities plant, storage facilities, etc., are allocated to different geographical segments on a reasonable basis, such common assets and related liabilities should also be allocated to segments based on utilisation by each segment or any other reasonable basis.
D. Opinion
16. On the basis of the above and subject to paragraph 9 above, the Committee is of the opinion that there appears to exist atleast two geographical segments, viz., domestic sales and export sales, as discussed in paragraph 11 above. Other geographical segments, if any, should be evaluated on the basis of considerations as stated in paragraphs 11 and 12 above. The disclosures regarding various segments should be made as per the requirements (paragraphs 38 to 59) of AS 17.
1Opinion finalised by the Committee on 6.2.2012
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