Segment reporting is a critical aspect of a company’s financial reporting as it provides information about the company’s operations and financial performance.
This information is used by investors, analysts, and other stakeholders to assess the company’s financial health and performance.
As a result, auditors must conduct thorough audit procedures to ensure that the segment reporting is accurate and reliable.
This article will discuss best practices for conducting audit procedures for segment reporting.
Accounting Under IFRS:
Segment reporting is covered under IFRS 8 – Operating Segments. This standard requires a company to disclose information about its operating segments in its financial statements.
An operating segment is a component of a company that engages in business activities, has financial results, and whose performance is regularly reviewed by the company’s management.
IFRS 8 requires that a company disclose the following information about its operating segments:
- Revenue from external customers and inter-segment revenue.
- Results of the operating segment (e.g., operating profit, profit before tax, etc.).
- Assets and liabilities of the operating segment.
- Capital expenditure on non-current assets of the operating segment.
- Depreciation and amortization of the operating segment’s non-current assets.
Auditors must ensure that a company has recognized its operating segments correctly and has provided accurate and reliable information in its financial statements.
The following are ten audit risks that auditors must consider when conducting audit procedures for segment reporting:
- Misstatement of segment information due to incorrect application of accounting standards.
- Misclassification of business activities results in the misstatement of segment information.
- Needs to be adequate documentation of segment information.
- Inadequate internal controls over segment reporting.
- Overstated revenue or assets in segments to improve the overall company financial results.
- Understated liabilities or expenses in segments to improve the overall company financial results.
- Management bias in segment reporting.
- Incorrect allocation of costs between segments.
- Inadequate disclosure of segment information in financial statements.
- Inadequate disclosure of significant changes in the segment structure or reporting.
Auditors use assertions to evaluate the financial information presented in the financial statements. The following are the key assertions that auditors use for segment reporting:
- Completeness – all operating segments are included in the financial statements.
- Existence – the operating segments exist, and their financial results are accurately reflected.
- Accuracy – the financial information reported for each segment is accurate.
- Valuation – the segment assets and liabilities are valued correctly.
- Allocation and presentation – the operating segment’s costs are accurately allocated between segments and presented correctly in the financial statements.
Walkthrough testing is a critical procedure that auditors use to ensure that internal controls are working effectively. In the context of segment reporting, auditors may follow the process below to conduct walkthrough testing:
- Understand the company’s process for identifying operating segments and segment reporting.
- Review the company’s segment reporting policies and procedures.
- Test the operating effectiveness of the company’s internal controls over segment reporting.
- Identify and evaluate any control deficiencies or weaknesses and document any recommendations for improvement.
- Existence or Occurrence: Ensuring that the reported segment information exists and that the segment has been operated during the period in question.
- Completeness: All segments have been identified, and none have been excluded from the report.
- Accuracy: Ensuring that segment information is accurately recorded in the financial statements.
- Classification: Confirm that segment information is presented in the correct financial statement line item and that the segment information is not inappropriately combined or separated.
- Timing: Ensuring that segment information is recorded in the correct accounting period and that any revenue or expenses have been properly allocated.
- The auditor should test the design and implementation of the company’s internal controls to ensure that the segment reporting process is accurate and reliable.
- The auditor should trace the data used for segment reporting back to the source documents, such as sales invoices or employee payroll records.
- The auditor should perform analytical procedures on segment information, such as comparing segment results to prior years or to industry benchmarks, to assess the reasonableness of the segment information.
Test of Control:
- The auditor should test whether the company has a process for identifying and aggregating operating segments and whether the company’s management has the necessary skills and knowledge to identify the operating segments.
- The auditor should assess whether the process for preparing segment disclosures has been consistently applied across reporting periods.
- The auditor should review the company’s internal controls related to the segment reporting process, including any IT systems that support the process.
Substantive Audit Procedures:
- The auditor should perform detailed testing of segment revenues and expenses, including testing the accuracy of any allocations or apportionment of costs.
- The auditor should review intercompany transactions to ensure they have been properly eliminated from segment disclosures.
- The auditor should assess whether the company has appropriately disclosed the risks and uncertainties associated with its operating segments.
- The auditor should perform a detailed review of related party transactions to ensure that they have been appropriately disclosed in the segment disclosures.
- The auditor should review any significant changes in the company’s segment reporting methodology to assess the impact on the financial statements.
- The auditor should assess whether the company’s disclosures regarding its segment reporting process comply with IFRS requirements.
- The auditor should assess whether the company has disclosed any goodwill or intangible assets associated with the segments and whether they have been appropriately recognized and measured.
- The auditor should review any capital expenditures made by the company and assess whether they have been appropriately allocated to the segments.
- The auditor should review the company’s segment disclosures to ensure that they are consistent with other information in the financial statements.
- The auditor should assess whether the company has appropriately disclosed any discontinued segments and the financial impact on the company’s financial statements.