Non-GAAP Measures and Segment Reporting

It’s not often that I get to combine TWO of the most cited issues in SEC comment letters into ONE post, but today is my lucky day (and yours)! Segment reporting allows investors to see the company “through the eyes of management,” while non-GAAP measures help companies “better tell their story.” The main difference is that one of these requirements companies are eager to disclose, while the other not so much! In this post we discuss non-GAAP measures and segment reporting. Specifically, whether public companies are allowed to disclose non-GAAP measures within their segment reporting footnote in their U.S. GAAP financial statements.

Reminder of segment reporting requirements under ASC 280

ASC 280 outlines a management approach and requirements for public entities to report certain information about operating segments in their U.S. GAAP financial statements. Such information allows investors and potential investors to see the company “through the eyes of management.” The starting point is to determine the operating segments of the entity.

Determining operating segments

According to ASC 280, an operating segment is a component of a public entity that meets all of the following characteristics:

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

Reportable segments and required disclosures

Once we’ve determined the operating segments, we need to determine the reportable segments and make appropriate disclosures. The process for determining reportable segments in accordance with ASC 280 has been summarized in the image above.

For each reportable segment, public entities are required to disclose:

• General information about the factors used to identify reportable segments and the types of products/service from which each reportable segment derives its revenues
• Information about the segment’s profit or loss and assets
• Information about the segment’s investments and expeditures
• Information about the measurement of the segment’s profit or loss and assets
• Several reconciliations from the segment footnote to the consolidated financial statements
• Entity-wide information about products/services, geographic areas, and major customers

For more information about segment reporting and where companies are getting it wrong, check out this post or our online course ASC 280: Segment Reporting.

Improvements to reportable segment disclosures (ASU 2023-07)

The FASB issued ASU 2023-07 Segment Reporting (Topic 280): Improvements to Segment Disclosures to improve the disclosures about a public entity’s reportable segments and address requests from investors for additional, more detailed information about a reportable segment’s expenses. The amendments in this ASU introduce a disclosure principle that would require public entities to report, on an annual and interim basis, incremental information about significant segment expenses included in a segment’s profit or loss measure. It also requires disclosure of the amount and composition of other segment items.

Significant segment expenses

As noted above, a public entity must disclose for each reportable segment the significant expense categories and amounts that are regularly provided to the CODM and included in reported segment profit or loss. When determining “significance,” public entities should consider both quantitative and qualitative factors, from the standpoint of the users of the financial statements, not the company.

Examples of significant segment expenses that could be disclosed as a result of the ASU:

• Cost of revenue
• R&D expenses
• Nonmanufacturing payroll expense
• Professional services expense
• Interest expense

The significant segment expenses disclosed may differ between public entities in the same industry, and even within segments of the same entity!

Other segment items

Other segment items is the difference between segment revenues less the significant segment expenses disclosed under the significant expense principle and each reported measure of segment profit or loss. In other words, it is essentially the “plug” to reconcile back to the segment profit or loss reported.

Public entities are required to disclose for each reportable segment on an annual and interim basis an amount for other segment items. In addition, public entities are required to provide a description of the composition, including the nature and type of other segment items.

Effective date of ASU 2023-07

ASU 2023-07 is effective for public entities for fiscal years beginning after December 15, 2023, so we should begin to see some actual disclosures soon when calendar-year-end entities begin filing their annual reports with the SEC on Form 10-K later this month.

Reminder of SEC requirements for non-GAAP measures

Over 90% of companies use non-GAAP measures in SEC filings, earnings releases, and other public disclosure to better “tell their story.” However, as we discuss later in this post, they are also the number one topic of SEC comment letters.

What are non-GAAP measures?

A non-GAAP measure is a numerical measure of a registrant’s historical or future performance, financial position, or cash flows that:

• Excludes amounts that are included in the most directly comparable measure calculated and presented in accordance with GAAP; or
• Includes amounts that are excluded in the most directly comparable measure calculated and presented in accordance with GAAP.

Examples of commonly disclosed non-GAAP measures include EBITDA; adjusted revenue, earnings, or EPS; free cash flow; and core earnings.

Applicable guidance on non-GAAP measures

Disclosure of non-GAAP measures is only really a public company issue. As such, it is the SEC that is providing the applicable guidance which includes:

• Regulation G
• Item 2.02 of Form 8-K
• Item 10(e) of Regulation S-K

In addition, the SEC has also published their interpretations of these regulations in the form of Compliance and Disclosure Interpretations (C&DIs). Although technically the C&DIs are non-authoritative, you best believe that public companies (and their auditors) look to them for guidance for disclosure of non-GAAP measures!

Requirements for non-GAAP measures

Besides the overriding requirements in Regulation G that non-GAAP measures cannot be misleading, the SEC requires that companies:

• Present the most directly comparable GAAP measure with equal or greater prominence
• Present a reconciliation of the differences between the non-GAAP measure and the most directly comparable GAAP measure
• Provide a statement disclosing the reasons why management believes the presentation of the non-GAAP measure provides useful information to investors
• Disclose the additional purposes, if any, for which management uses the non-GAAP measure

Non-GAAP measures included in an SEC filing must comply with Item 10(e) of Regulation S-K, which includes the requirements in Regulation G and Item 2.02 of Form 8-K. In addition, Item 10(e) sets out several prohibitions related to their use. One such prohibition is that registrants are prohibited from presenting non-GAAP measures on the face of the GAAP financial statements or the accompanying footnotes. However, as we discuss below, ASU 2023-07 might change this prohibition!

For more information about non-GAAP measures and where companies are getting it wrong, check out this post or our online course SEC Reporting: Non-GAAP Financial Measures.

SEC comments: Non-GAAP measures and segment reporting

Example SEC comments on non-GAAP measures

As you can see in the image above, non-GAAP measures are the number one issue cited in SEC comment letters. Specifically, the SEC staff has focused on the following areas all of which have been highlighted in their updated C&DIs:

• Presentation with equal or greater prominence of the most directly comparable GAAP measure
• Reconciliation of the non-GAAP measure to the most directly comparable GAAP measure
• Appropriateness of the adjustments such as elimination of normal, recurring cash operating expenses and labeling items as non-recurring, infrequent, or unusual when they are not
• Use of individually tailored accounting principles
• Disclosure of why management believes that the non-GAAP measure provides useful information to investors

Example SEC comments on segment reporting

Segment reporting has also been a consistent area where the SEC has issued comments. Some of the most frequently cited issues surrounding segment reporting include:

• Identification of operating segments and how companies identified the CODM
• Aggregation of operating segments into reportable segments
• Expectations to see changes in segments when entity has reported certain events (e.g., acquisitions or dispositions)
• Completeness of entity-wide information required to be disclosed
• Segment profit or loss measures and inclusion of non-GAAP measures in the disclosure

Note that the last “finding” in the segment issues list above was BEFORE the adoption of ASU 2023-07 (as discussed above) and is addressed in the question below.

Can companies include non-GAAP measures in their segment reporting footnote?

In their comment letters, the SEC has observed companies disclosing multiple measures of segment profit or loss in the segment disclosures and asked them to revise their disclosures to provide only a single measure of profit or loss for each reportable segment. Furthermore, as we previously discussed, Item 10(e) of Regulation S-K prohibited the disclosure of non-GAAP measures within the GAAP financial statements and related notes. However, this prohibition does not apply to segment reporting in accordance with ASC 280 after the adoption of ASU 2023-07.

ASU 2023-07 permits public entities, including those with a single reportable segment, to report multiple measures of a segment’s profit or loss if the CODM uses more than one measure of a segment’s profit or loss. And this includes non-GAAP measures, if they are used by the CODM to assess performance and allocated resources! If a company uses more than one measure of a segment’s profit or loss, at least one of the reported measures should be a measure that management determines in accordance with GAAP.

During the 2024 AICPA & CIMA Conference on Current SEC and PCAOB Developments, SEC staff stated they would not object to entities disclosing non-GAAP measures in their segment reporting footnote provided these measures otherwise comply with the SEC’s existing guidance on non-GAAP measures. This would include a reconciliation of the non-GAAP measure to the most directly comparable measure under GAAP.

Are auditors now responsible for auditing non-GAAP measures if they are included in segment disclosures?

If an entity discloses a non-GAAP measure within its segment disclosures, this measure and the related disclosures required by ASC 280 cannot be labeled “unaudited” because they are required by GAAP. If a non-GAAP measure is used in the segment footnote, the entity must follow the SEC requirements. This includes ensuring that the measure is not “misleading” and providing the required reconciliation.

However, the SEC staff was clear that the auditor is not required to ensure compliance with the SEC requirements for non-GAAP measures. This means the auditor is not responsible for considering whether the measure is or is not “misleading” or having to audit the related reconciliation. Any information within the GAAP financial statements that is not audited should be clearly labeled “unaudited.”

Disclosing both GAAP and non-GAAP measures within the same footnote could be confusing to a user of the financial statements. Therefore, the auditor should consider including an emphasis of matter paragraph within their opinion explaining which items are part of the audit and which are not.

Final thoughts

Honestly, disclosing non-GAAP measures within your segment reporting footnote seems like more trouble that it is worth. If you want to disclose non-GAAP segment measures, I’d probably stick to disclosing them in the MD&A. Just be sure you follow all the SEC guidance of course!

Well, that was quite the journey (and I was trying to be succinct)! Check out this online course if you’d like to know more about segment reporting, including the requirements of ASU 2023-07. Interested in learning more about non-GAAP measures? Check out our Stranger Things-inspired eLearning course!

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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.