What is it about segment reporting under ASC 280 that makes it a perennial hot topic among regulators? Like a stupid song you can’t get out of your head, it keeps coming back over, and over, and over… And again, it made an appearance for the umpteenth time at the AICPA Conference on Current SEC and PCAOB Development.

In theory, the requirements of ASC 280 are not that difficult – to provide information about the different types of business activities in which an enterprise engages and the different economic environments in which it operates. This information helps users of the financial statements:

• Better understand the enterprise’s performance;
• Better assess its prospects for future cash flows; and
• Make more informed judgments about the enterprise as a whole.

Using a management approach, ASC 280 defines operating segments as a component that:

• Engages in business activities from which it may earn revenues and incur expenses;
• Has operating results that are regularly reviewed by the enterprise’s chief operating decision maker (CODM); and
• Has discrete financial information that is available.

The management approach is based on the way that management organizes the segments within the enterprise for making operating decisions and assessing performance. This approach is modified to require reporting on a reasonable number of segments. If too many segments are identified aggregation criteria are used to develop a smaller number of reportable segments. Quantitative thresholds are used to determine the minimum number of operating segments that must be reported.

So, where are companies getting it wrong? During the AICPA Conference, Nili Shah, Deputy Chief Accountant in the Division of Corporation Finance, noted two areas of recent SEC comments regarding segment reporting under ASC 280:

• Identification of operating segments; and
• Aggregation of operating segments

Let’s look at two class examples within our training materials that will hopefully highlight the issues noted by the SEC in these areas.

Identification of Operating Segments

The answer to the question is probably not. Although sufficient information is not provided to answer the question definitively, the following issues would need to be investigated:

Is the CEO the CODM and, therefore, only two segments exist?

The SEC staff has noted that they have seen companies default to the CEO as the chief operating decision maker (CODM) and urged registrants to take a fresh look at those determinations, considering what the key operating decisions are and who is making these key decisions. They will continue to ask questions to obtain a better understanding of a registrant’s management structure and determine whether that structure supports the individual or individuals identified as the CODM.

In this example, although the CEO only reviews the financial information of two segments, the CFO and COO (also executives) review (on the consumer side) financial data from three specific business units. In some cases, the CODM may be more than one person within the organization (i.e., the CODM is not necessarily a “person”, but rather a “function” of the entity).

In summary, it is incorrect to conclude that the CODM is the CEO simply because that individual has “ultimate decision-making authority.” The SEC Staff cautioned that ultimate decision-making authority is not included in the definition of the CODM.

Have the operating segments been properly identified?

ASC 280 states that an operating segment is often evident from the structure of a company’s internal organization, but the SEC has cautioned that this does not mean that “simply looking at the entity’s organization chart” would provide a sufficient basis to identify its operating segments. The SEC staff also cautioned against over-relying on the information package provided to, and regularly reviewed by, the CODM noting that this is only one factor to consider, and it is not necessarily determinative. Additionally, the SEC staff encouraged registrants to consider the basis on which budgets and forecasts are prepared and the basis on which executive compensation is determined when identifying its operating segments.

In this example, the fact that financial information from business units within consumer banking was used for forecasting, budgeting, and setting compensation could indicate that these business units are also operating segments.

Aggregation of Operating Segments

The answer to the question is no. Only segments E and F could be combined into one reportable segment.

ASC 280 permits an entity to aggregate operating segments if the aggregation is “consistent with the objective and basic principles of ASC 280-10 and if the segments have similar economic characteristics.” Because ASC 280-10 does not define the term “similar” or provide much guidance on the aggregation criteria, the determination of whether two or more operating segments are similar depends on the individual facts and circumstances.

Aggregating operating segments is a process consisting of 4 steps.

Step 1: Determine if all or some operating segments have similar economic characteristics and meet ALL the aggregation criteria.

The aggregation criteria are:

• Similar nature of products and services
• Similar nature of production processes
• Similar type or class of customer for their products and services
• Similar methods used to distribute their produces or provide their services
• Similar nature of regulatory environment

If any operating segments meet ALL the criteria, these operating segments should be aggregated first into a single operating segment. After assessing this first step, entities can continue to step two (note that this step can result in two or more operating segments being combined into a single operating segment – which is different from a reportable segment).

Step 2: Determine if operating segments meet any of the quantitative thresholds and report them as a separate operating segment.

The quantitative thresholds (based on the consolidated entity) are:

• 10% of revenues
• 10% of net income/loss (on an absolute basis)
• 10% of total assets

If any operating segments meet any of these quantitative thresholds, it becomes a reportable segment.

Step 3: For those operating segments that do not meet the aggregation threshold (Step 1), determine if some of the operating segments have similar economic characteristics AND meet not all, but a majority of the aggregation criteria and report them as a reportable segment.

Step 4: Determine if reportable segments account for 75% of consolidated revenues.

If reportable segments do not comprise 75% of revenues, report additional reportable segments until the 75% threshold is met (i.e., until the “all other” category is 25% or less).

Let’s review these steps as it relates to Frisbee Corp. in our class example:

• Step 1: None of the segments meet ALL the aggregation criteria. Therefore, segments A-H are individual operating segments.
• Step 2: Operating segments A, B, C, and D meet at least one of the quantitative thresholds. Therefore, these operating segments must be reported separately (i.e. they are reportable segments).
• Step 3: As segment D is already being reported separately, only segments E and F can be aggregated into a reportable segment because (a) they have similar economic characteristics and (b) a majority of the aggregation criteria have been met.
• Step 4: The revenue threshold has been meet for reportable segments as 97% of external revenues are included. Therefore, neither segment G or H are required to be separately reported, but can instead be reporting within an “All Other” category.

In summary, Frisbee Corp. would report the following reportable segments in accordance with ASC 280:

• Segment A
• Segment B
• Segment C
• Segment D
• Segment E/F
• All Other (segments G/H)

We hope that these examples of help to illustrate some of the issues continually noted by the SEC with respect to segment reporting under ASC 280. As always, if you have any questions, please do not hesitate to contact us directly.

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