Accounting for Segment Reporting: How to Report with Clarity and Respond to FASB Updates
By understanding the critical aspects of segment reporting, accounting teams can ensure audit readiness, anticipate regulatory updates, and provide valuable insights for decision-making.
The identification of segments can seem straightforward, but, in practice, this can be one of the most judgment-based and complex areas for a financial reporting team.
Segment reporting is a critical element in providing transparency to stakeholders by breaking down a company’s financial information into segments to provide a clearer picture of its performance. Several segment reporting considerations can affect public company CFOs, their accounting teams, and an organization’s audit readiness. In particular, accounting and financial reporting professionals should examine the latest principles for identifying operating and reportable segments, analyze current disclosure requirements, and understand the best approaches for reconciling entity-wide disclosures. Additionally, the Financial Accounting Standards Board (FASB) has recently issued an update to segment expense disclosure requirements, which will impact segment reporting.
Segment reporting: why it matters
The major objective of segment reporting is to provide information that helps users of financial statements better understand the enterprise’s performance and different types of business activities. Segment reporting provides insight into risks, opportunities, and the company’s overall performance. Segment information is one of the most heavily utilized by investors in their review of a company’s performance, as it provides insight into how the company is managed and allows investors to understand company performance on a more disaggregated level.
Segment reporting examples
For illustrative purposes, a sports-themed company might report on three segments, such as its core business, in which 70% of the company’s revenue comes from consumer products such as retail sporting goods, 17% from entertainment offered at sports-themed event spaces, and 13% from education services tailored for athletic coaches. The disaggregation of data by product offering may provide information about the profitability of each segment and how resources should be allocated from a management perspective. This information, when combined with other public statements and disclosures, could signal relevant information for investors, auditors, and decision makers.
Geography can also be an influencing factor. For example, a professional services firm could have a large segment in North America and additional growing segments across three other global regions. While the services offered in each geographic area might appear quite similar firmwide, the different geographies may be managed independently of each other to take into account the various nuances of each geography. Each of these factors will influence decisions and resource allocations by segment.
Identifying operating and reportable segments
Operating segments are identified based on the management approach, which ultimately rests with the chief operating decision maker (CODM). The CODM is responsible for allocating resources and assessing performance for the operating segments. The primary basis for determining operating segments is how the CODM reviews performance in order to make those decisions. The CODM may consider factors such as product lines, customer segments, or geographic regions.
Once a company has identified its operating segments based on whether the segment is a business that has discrete financial information regularly reviewed by the CODM, reportable segments are determined based on quantitative thresholds and the principles of aggregation. Under ASC 280, public companies must report every segment that meets at least one of the following tests: (1) it earns 10% or more of the company’s total revenues, (2) its profit or loss is 10% or more of the combined profits or losses of all operating segments, or (3) its assets are 10% or more of the company’s total assets. If a segment fails any of these tests, it can be aggregated with other similar segments to create reportable segments.
The identification of segments can seem straightforward, but, in practice, this can be one of the most judgment-based and complex areas for a financial reporting team. Here are some factors that make it challenging to accurately identify a company’s segments:
- The CODM may utilize multiple views of the business when allocating resources. It’s not unusual for CODMs (especially those in large, complex businesses) to utilize multiple views for decision-making, such as product lines and geographic breakdowns of the business. Determining which view is the most prevalent for disclosure purposes can be challenging and require input from leaders.
- Reporting packages may contain superfluous information not utilized in decision-making, which makes it difficult to evaluate how the CODM actually reviews the business.
- The financial reporting package may not be updated to reflect changes to how the company wants to manage the business. Company management may want to change how they review the business to account for changes in economic conditions or industry happenings, and the finalized look may not be ready before segment reporting is required.
Segment disclosure requirements and FASB updates
Historically, segment reporting has required an entity to disclose each reportable segment’s revenue, the selected key profit or loss measure, the total assets, and the allocation of depreciation expense. Under the guidance issued in November 2023, companies will also be required to disclose significant expenses by reportable segment, who the CODM is, and how the CODM uses the reported measure of segment profit or loss in assessing segment performance. These disclosures are essential to provide transparency to stakeholders. Additionally, entity-wide disclosures and reconciliations ensure consistency and comparability between segment reporting and primary financial statements.
At the latest AICPA conference, the FASB remarked on guidance that it had recently issued, comparing differences between segment disclosures in the past versus the new disclosures that are expected. Key changes include the ability for companies to disclose more than one measure of profit used by the CODM, whereas, historically, companies had been expected to disclose information using only one key measure of profit. Now, the FASB will allow more than one measure to be utilized, but the US Securities and Exchange Commission clearly stated that any additional measures that are non-GAAP measures would be subject to the same non-GAAP guidance and scrutiny as other non-GAAP measures. This change is expected to provide more insight into how company management views the business.
The right level of detail for accountants, regulators, and auditors
A company’s income statement provides a consolidated view of financial reporting information, while the segment footnote provides additional detail, and investors regularly comment about the importance of the segment footnote as a way to get more granular detail regarding the performance of a business. Various stakeholders might be at odds regarding the right level of detail within a segment footnote. Accounting and finance teams usually want to show fewer segments and a simplified view of a company’s segment reporting, while investors typically want more granularity. Preparers of financial statements may prefer to show fewer segments because of the complexity of compiling the data, which then becomes subject to audit procedures due to the inclusion of the data in the footnotes.
The protection of competitive information is another reason preparers might prefer to show fewer segments. While the SEC has been sympathetic to perceptions that disclosure of certain information may give competitors too much insight into how a business is run, the demands of investors are always heavily considered in their desire to have more insight into how a business is actually managed for investment decisions.
Which segment reporting measures to include
A company might look at several key performance indicators (KPIs) in order to assess the business performance (gross margin, EBITDA, return on assets, or other measures). Under GAAP, accounting and finance professionals historically have been required to pick one measure of profit that the company most uses to allocate resources and make business decisions. This means even if the CODM regularly evaluates multiple KPIs, GAAP requires company accountants to pick one KPI and reconcile it to the nearest measure (such as EBITDA reconciled to net income).
This can play out in various ways depending on the company. For example, a common KPI for companies is based on EBITDA or adjusted EBITDA, as it purports to approximate actual operating cash flow. For a retail company like the sporting goods brand illustrated above, the primary indicator of the company’s performance might be its profit margin (so that each segment isn’t burdened by large corporate costs shared across multiple segments).
Under the new guidance (ASU 2023-07), segment reporting can show more than one measure. The Accounting Standards Update states that “in addition to the measure that is most consistent with the measurement principles under GAAP, a public entity is not precluded from reporting additional measures of a segment’s profit or loss that are used by the CODM in assessing segment performance and deciding how to allocate resources.” The new guidance also stipulates that reporting must show more detailed information by segment, including significant expenses, and that all companies, even those with just one segment, must include these disclosures.
At the 2023 AICPA conference, the SEC noted that if a company plans to adopt the standard early and include a non-GAAP measure in its segment footnote (such as adjusted operating profit), then the company needs to review the information with the SEC before including the information. By making this recommendation, the SEC appears to be proactively avoiding concerns over highly unconventional measures.
Segment reporting is an essential element in ensuring audit readiness and providing transparency to stakeholders. Accounting teams must have a clear understanding of the principles of identifying reportable segments and meeting disclosure requirements. Additionally, engaging the support of third-party accounting advisory partners can provide much-needed guidance and support in navigating reporting complexities. With careful attention to detail and a strong adherence to reporting principles, accounting teams can ensure audit readiness and provide value to the various stakeholders involved in the financial reporting process.