Long a thorn in the side of preparers and regulators alike, segment reporting rules may finally be getting a tune-up designed to make compliance more straightforward.
Accounting Standards Codification Topic 280 on segment reporting tells companies they must give investors some insight into how the company parses out different operating segments depending on how they manage the business. If a company manages its affairs in segments of some kind—perhaps by product or brand, by location or geographic region, or by division or subsidiary, for example—then it must report those segment results to investors accordingly.
The rules are not terribly prescriptive about how a company should identify its segments and separately report those results, says Angela Newell, national assurance partner at BDO USA. “This is one of the few areas of GAAP that is written for the management approach,” she says. “There are few bright lines other than to report on the same basis that management uses to manage the business.”
The idea behind the approach is to allow companies to report to investors according to how they manage and operate the business. It allows financial statement users to see the business as management sees it and to assess the company’s performance and potential to produce cash flow through the same lens, says Mike Morrissey, senior consultation partner at Deloitte & Touche. “Each company has its own segment structure reflecting how it is organized,” he says.
The rules on segment reporting have been around since the late 1990s. The Securities and Exchange Commission has been issuing comments with concerns on segment reporting for almost as long. It’s a perennial topic of discussion when accountants and regulators gather at their annual year-end financial reporting conference, says Newell. “It continues to be in probably the top five comment areas at the SEC, and it’s been that way for at least 10 years or longer,” she says. “It’s always out there.”
That’s inspiring the Financial Accounting Standards Board to take a fresh look at its rules on segment reporting to see if a different approach is warranted. The board is looking for companies to participate in a study of two alternatives it has developed for how to revise the rules.
“Often when you run into issues with the SEC staff, where it’s most difficult, most of the time it’s because things are not well documented.”
Graham Dyer, Partner, Grant Thornton
The current rules tell companies they must identify their segments according to how senior executives manage the business, but it also tells them to aggregate segments to some degree so the reporting won’t become overly wieldy. GAAP tells companies 10 operating segments is a practical limit in terms of the number of ways the business should be carved up and described to investors.
That introduces an element of judgment, and therein lies the difficulty with applying the standard. Companies with multiple operating units must determine how best to group them, says Mark Shannon, managing director for the assurance professional practice at Crowe. “Aggregation is not so much quantitative as qualitative,” he says.
Companies must consider the economic characteristics of different segments, Shannon says. The standard says the analysis should take into account long-term gross margins as an example. “Practice has developed as to what that means,” he says.
Beyond economic characteristics, the analysis must also consider the nature of products or services offered by different segments, the nature of their processes, the type of customers, and the way products or services are distributed, even regulatory environments, says Shannon. “It can be difficult to parse through all of that.”
FASB seeks comment
The FASB is conducting outreach with preparers to consider improvements to the aggregation criteria and the reportable segments process. The Board is currently seeking public companies to test the operability of two potential alternatives and to identify any unintended consequences.
The Board is seeking public companies that have multiple operating segments and apply the aggregation criteria in the Accounting Standards Codification Topic 280, Segment Reporting. If you are interested, please tell us more about your organization by clicking on the link below and registering.
The FASB has a project on its technical agenda to improve the segment reporting requirements within Topic 280.
The project is not looking to fundamentally revise Topic 280. However, it is targeting two aspects of the segment reporting requirements for improvement. First, it seeks to improve the segment aggregation guidance and the reportable segments process, as is being analyzed in the current study. Second, it seeks to improve the segment disclosure and reconciliation requirements, as will be analyzed in a separate study in 2019.
As part of the project, the FASB is seeking public companies to participate in a study to help the Board better understand issues preparers may face in applying different potential alternatives to improve the existing segment aggregation criteria and reportable segments process.
What Alternatives Are Being Considered?
The outreach will focus on two potential alternatives:
Reorder the process for determining reportable segments and move the quantitative thresholds earlier in that process
Remove the aggregation criteria, thereby each operating segment would be reportable until a practical limit is reached.
How Will the FASB Use Information Obtained from the Study?
The feedback received during the study will help inform the FASB about the costs and benefits of the different alternatives to improve the aggregation criteria and the reportable segments process. A summary of the findings will be presented to the Board at future public FASB meetings. Individual feedback will be kept confidential.
Technology has perhaps made the analysis even more difficult over time as companies get deeper and more timely insight, says Newell. If executives are looking at data that drills deeper into specific operating areas and using that data to make decisions, that factors into the equation, she says. “That’s the crux of the SEC comments, typically,” she says. “The SEC sometimes believes management may be managing the business at a lower level than what they’re disclosing.”
FASB is looking for companies to assist with a study of two possible alternatives to revise the rules. One idea is to re-order the analysis of how to aggregate operating segments, to make the identification of segments above a certain threshold more straightforward. Another idea is to eliminate aggregation and simply require companies to report segments according to how they are managed, however many segments that may be, until some practical limit is reached. The board wants to determine how reportable segments would change under the different approaches, any unintended consequences that might arise, and any operability concerns.
“Having an opportunity to do that dry run is incredible, particularly if you have a lot of operating segments,” says Shannon. “To the extent you’re a company that has struggled with segments historically, this is your opportunity to help shape how you might be reporting in the future.”
In the meantime, companies need to rely on good controls and procedures to identify and report their segments, says Shannon. “Where many people fall down is if you’ve had a change in the information that the chief operating decision maker is looking at, that can cause a change in segments,” he says. “If you don’t have controls that identify when there are changes, that can be problematic.” Changes in management structure can also signal changes in the way segments ought to be reported, he says.
When the SEC studies a company’s segment reporting, it compares what the company provides in its regulatory filings with other information the company produces, like press releases or earnings calls. “Make sure all your information is consistent,” says Newell.
Documentation is also key, says Graham Dyer, a partner at Grant Thornton. Companies need a well-defined and well-documented process for providing periodic reporting to senior management that is consistent with segment disclosures.
It’s tricky to convince the SEC staff of how management manages the business if it’s undocumented. “Often when you run into issues with the SEC staff, where it’s most difficult, most of the time it’s because things are not well documented,” says Dyer.