Segment Reporting and Reporting Unit Analysis

Segment reporting continues to be a focus area of financial reporting for public companies. Segment reporting is the reporting of segments of a company, as well as the financial results of those segments, in the disclosures accompanying a public company’s financial statements. Private companies are not required to report segments. The guidance for segment reporting is covered under ASC 280, Segment Reporting.

The objective of ASC 280 is to require companies to provide information about their different types of business activities and help financial statement users:

1. Better understand the Company’s performance
2. Better assess the Company’s prospects for future net cash flows, and
3. Make more informed judgments about the Company as a whole

In developing the guidance included in ASC 280, the FASB recognized that there are many ways in which they could require companies to present their information (by service, product, geography, legal entity, etc.), but feel that the approach that best captures the true intention of the statement is the management approach. The management approach is based on the idea that management should report segment information in public filings in the same manner that they organize the segments within the company’s financial reporting systems used for making operating decisions, assessing performance and allocating resources.  This article focuses on the identification of a company’s operating segments, reportable segments and reporting units.

Identify Operating Segments

The first step in determining a company’s segments is to identify the company’s operating segments using the management approach. ASC 280 defines an operating segment as a component of a Company:

1. that engages in business activities from which it may earn revenues and incur expenses,
2. whose operating results are regularly reviewed by the Company’s chief operating decision maker (CODM) to make decisions about resources to be allocated to the segment and assess its performance, and
3. for which discrete financial information is available.

Engages in business activities

To be an operating segment, a component must engage in business activities that cause it to incur expenses and potentially recognize revenue. Certain functional departments or cost centers (e.g., corporate headquarters, corporate shared services, etc.) that do not recognize revenues would not generally be operating segments. However, a division that only performs R&D activities may be considered an operating segment if there is discrete financial information available and the operating results are reviewed regularly by the CODM. Even a startup operation that has not yet earned revenues may meet the requirement of engaging in business activities.

Operating Results are Regularly Reviewed

The second criteria to be an operating segment is that the CODM has to regularly review the component’s operating results to assess performance and make decisions about allocating resources.  That is, the CODM makes key operating decisions based on financial information for the component.

In accordance with ASC 280, the CODM identifies a function rather than an individual with a specific title. The function of the CODM is to assess performance and make decisions based on that performance, be responsible for overall resource allocation, and be viewed as the highest level of management at which decisions are made. 

Discrete Financial Information is Available

The CODM must have discrete financial information available about the component in order to assess performance and make resource allocation decisions. Discrete financial information usually captures key operating information (e.g., revenue, operating profit/loss, etc.). Generally, assets are not required to be allocated to a component for it to have discrete financial information. However, this financial information must be sufficiently detailed to allow the CODM to make decisions. Discrete financial information is usually provided to the CODM in a monthly reporting package.

Other Considerations

The CODM may look at multiple types of segment info (e.g., geographical, product line, etc.), particularly those in multinational companies with diverse operations. When more than one set of segment information is used, the following need to be considered to determine the entity’s operating segments:

• Nature of business activities: The nature of activities of some entities and the composition of a company’s business may be organized and reported more logically one way than another or be more significant than the other to the company as a whole.
• Existence of segment managers: An operating segment typically has a segment manager who oversees all aspects of the segment and reports directly to the CODM.
• Information presented to the BOD: If only one type of financial information is presented to the board of directors, that type of data generally is indicative of the company’s operating segments. If the BOD receives overlapping information, the business components distinguished by products and services generally would constitute the operating segments.

Identify Reportable Segments

Once a company has identified its operating segments, the next step is to determine its reportable segments that will be reported in the notes to its financial statements. In accordance with ASC 280, a company shall report segments that meet both of the following criteria:

• Has been identified in accordance with the operating segment guidance or results from aggregating two or more of those segments
• Exceeds the quantitative thresholds under ASC 280

Aggregating operating segments

The first step in identifying the company’s reportable segments is to determine which operating segments should be aggregated, if any. Operating segments that exhibit similar long-term financial performance should be aggregated as separately reporting each may not enhance the financial statement user’s understanding of the business. Each of the following criteria must be met in order to qualify for aggregation:

• Similar economic characteristics
• The nature of products and services
• Nature of their production processes
• Types of customers
• Distribution methods
• Nature of the regulatory environment

Quantitative thresholds

Once the operating segments have been aggregated, the next step is to determine which operating segments meet the quantitative thresholds to be reportable segments as follows:

• Operating segments must be separately reported if its revenues, profit/loss and assets are 10% or more of the combined measure of all operating segments. For those segments that do not individually meet this threshold, they may be combined if they share similar economic characteristics and a majority of the aggregation criteria above.
• After aggregating all the operating segments, the Company must determine whether the external revenue of the reportable segments make up at least 75% of total consolidated revenue. If they do not, additional operating segments that do not individually meet the quantitative thresholds must be broken out until the 75% revenue threshold is met.

The last step is to group all business activities that are not considered operating segments into a separate other category.

Identify Reporting Units

ASC 350 requires goodwill to be assessed for impairment at the reporting unit level, which is an operating segment, or one level below an operating segment (i.e., a component). A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component.

Components of an operating segment with similar economic characteristics will need to be aggregated into a single reporting unit. A reporting unit could be the same as an operating segment, which could be the same as a reportable segment depending on the level at which segments are reviewed, how many businesses the operating segment includes and the similarity of those businesses.

Components of each operating segment

First, the company needs to identify all the components of the operating segments. In order to qualify to be a component, the following are required:

• The component constitutes a business as defined in ASC 805
• Discrete financial information (operating information)
• Reviewed by segment management (one level below or the same level as the CODM)

Aggregation of the components of each operating segment

In accordance with ASC 350, two or more components within the same operating segment with similar economic characteristics should be aggregated into a single reporting unit. The following factors should be considered in determining whether the components of an operating segment have similar economic characteristics:

• The nature of the products and services
• The nature of the production processes
• The type or class of customer 
• The distribution methods used 
• If applicable, the nature of the regulatory environment.

However, not every factor needs to be met in order for two or more components to be considered economically similar. The following factors should also be considered in determining whether components should be combined into one reporting unit based on their economic similarities:             

• The manner in which an entity operates its business 
• Whether goodwill is recoverable from each component or together with other components 
• The extent assets and other resources are shared
• Whether common research and development projects benefit multiple components.