This study –
(a) surveys the relevant literature on • financial reporting by diversified companies and makes recommendations for reporting action by the managements of Australian diversified companies;
(b) tests recommendations emerging from the review of literature on a number of selected security analysts, sharebrokers, company managements and public accountants acting as auditors to companies; and
(c) highlights matters which require further research.
Recommendations Emerging from the Review of Literature
The review of literature led to the following recommendations:
1. For the purpose of external reporting, a diversified company should be defined as one which is so managerially decentralized, so lacks operational integration, or has such diversified markets that it may experience rates of profitability, degrees of risk, and opportunities for growth which vary within the company to such an extent that an investor requires information about these variations in order to make informed decisions.
2. the results of operations of a diversified company should be segmented on a basis which reflects most clearly the internal variations in the company's profitability, risk and growth;
3. the reportable segments of the diversified company should represent the company's operations which are substantial; most of the reportable segment's revenue should be derived from sales to external parties and only insignificant amounts, if any, from intra-company sales;
4. the effects of intra-company transfers on segment results should be minimized by reporting on the company's independent components and, by combining the transferor and transferee segments into one if the two are involved substantially in the intra-company sales. The insignificant intra-company transfers should either be eliminated from segment reports altogether or shown at a value decided by the management, provided the valuation method adopted is explained and followed consistently;
5. disclosure of segment results should include sales revenue, itemized separable costs of the segment and the contribution margin;
6. in order to obtain segmental disclosure from all diversified companies, a set of broad requirements of segment reporting should be imposed by law.
The above recommendations were tested by interviewing twenty-five security analysts and sharebrokers and by sending questionnaires to managements of sixty companies presumed to be diversified and forty-four public accountants acting as auditors to these companies.
Results of the Empirical Research
The following are some of the results of the three surveys:
1. The security analysts' and sharebrokers' concept of the diversified company was substantially similar to the definition of the diversified company emerged from the review of literature. The company managements' responses indicated that a number of companies were operating in Australia which could be regarded as diversified. The public accountants agreed that they were involved in auditing the accounts of diversified companies;
2. the security analysts and sharebrokers agreed unanimously that diversified companies should disclose segmental information. A majority of public accountants indicated that the investors would be better able to make decisions if segmented data was made available. However, a majority of company managements opposed segmented disclosure; they did not agree that such information was useful to the investors' decisions;
3. the security analysts and sharebrokers favoured segment disclosure ranging from sales revenue to segmented funds statement. Although a majority of the company managements indicated that they could provide information such as the segment's operating results up to the net profit, segmented balance sheet and funds statement, opposition to disclosure beyond the contribution margin was noticeable;
4. the accounting problems involved in carrying out segmented reporting, such as pricing of intracompany sales and allocation of common costs, were acknowledged by each group participating in the study. The public accountants agreed that the cost of additional audit and the wording of existing audit report could also present problems;
5. public accountants were willing to express audit opinions on segment reports showing sales revenue, separable costs of the segment and contribution margin. The majority of them would not express their opinions on segmental information beyond the contribution margin figure. Furthermore, they would be prepared to assist company managements by giving advice on the accounting and reporting aspects of segm.ent disclosure;
6. all the three groups approached indicated that in order to obtain disclosure from all diversified companies, mandatory requirements for additional disclosure would have to be imposed.
Matters Requiring Further Research
The cost of producing and auditing segmental information, the use of information by the competitors to possible disadvantage of the reporting company and the problems involved in preparation of segmented balance sheet and funds statement appeared to require further research.