Question

Washington—The Securities and Exchange Commission staff issued guidelines for companies grappling with the problem of dividing up their business into industry segments for their annual reports. An industry segment is defined by the Financial Accounting Standards Board as a part of an enterprise engaged in providing a product or service or a group of related products or services primarily to unaffiliated customers for a profit. Although conceding that the process is a “subjective task” that “to a considerable extent, depends on the judgment of management,” the SEC staff said companies should consider . . . various factors . . . to determine whether products and services should be grouped together or reported as segments.

Instructions

(c) Identify the possible disadvantages of requiring financial data to be reported by segments

Short answer

The main disadvantage of requiring financial data to be reported by segments is that it might result in misleading comparisons of segments of different enterprises.

Step-by-step solution

Meaning of Financial Statements

Financial statements are reports generated by a company's management to demonstrate the company's financial performanceand position at a certain moment in time. A balance sheet, income statements, statement of owner's equity, and statement of cash flows are usually included in a general-purpose collection of financial statements.

Disadvantage of requiring financial data to be reported by segments.

The following are some of the potential drawbacks of requiring financial data to be provided by segments:

1. Often they can be misinterpreted because of a general lack of public understanding of the limits of a relatively arbitrary basis for cost allocation.
2. They have the ability to obscure the interconnectedness of all components.
3. Competitors will gain access to confidential information about profitable or unprofitable products, plans for new products or market entry, apparent vulnerabilities that may prompt competitors to increase their own efforts to exploit the weakness, and existence is not indicated otherwise.
4. Those who read the operating figures reported by segment may be misled. Internal management segment data often includes arbitrary decisions that are known to the individuals who use the data and are used in the evaluation. Many believe that it is impossible to make such background material accessible and accessible to non-experts.
5. Making this information accessible could result in customers challenging prices, which would be detrimental to the Company.