Benefits

With many companies organized as conglomerates, the presentation of basic consolidated financial statements on an aggregated basis does not provide users with sufficient information for decision-making purposes. The objective of segment reporting, as set forth in ASC 280-10-1 is to

…Provide information about the different types of business activities in which an enterprise engages and the different economic environments in which it operates to help users of financial statements:

1. Better understand the enterprise's performance
2. Better assess its prospects for future net cash flows
3. Make more informed judgments about the enterprise as a whole.

The primary benefit of segment reporting is the release of “hidden data” from consolidated financial information. Different segments may possess different levels of profitability, risk, and growth. Assessing future cash flows and their associated risks can be aided by segment data. For example, knowledge of the level of reporting entity operations in a growing or declining product line can help in the prediction of cash flow, while knowledge of the scope of reporting entity operations in an unstable geographic area can help in the assessment of risk. In general, information about the nature and relative size of an enterprise's various business operations is considered useful by decision makers.

ASC 280 governs the way publicly held businesses are required to report disaggregated information in interim and annual financial reports to stockholders. The statement defines operating segments as distinct revenue-producing components of the reporting entity about which separate financial information is produced internally, and whose operating results are regularly reviewed by the reporting entity.

Management Approach

The disclosure approach adopted by ASC 280-10-05-03 and 04 is the “management approach,” meaning it is based on the way management organizes segments internally to make operating decisions and assess performance. The management approach, in general, provides that external financial reporting will closely conform to internal reporting, thus giving financial statement users the ability to view the reporting entity's segments in the same manner as internal decision makers.

Financial information can be segmented in several ways: by types of products or services, by geography, by legal entity, or by type of customer. ASC 280 provides a methodology to identify the operating segments that are separately reportable (referred to as “reportable segments”) and requires that each reportable segment disclose, among other items, its profit or loss, certain specific revenues and expenses, and its assets. Management is required to reconcile segment information with its consolidated general-purpose financial statements.

In addition, ASC 280 requires that all public companies report information on a company-wide basis about revenues for each product and service, about countries in which revenues are recognized and assets are held, and about its major customers, even if this information is not used by management in making operating decisions.

The Codification does not limit segment reporting to purely financial information. It also requires a description of the company's rationale or methods employed in determining the composition of the segments. This description includes the products or services produced by each segment, differences in measurement practices between segments and the consolidated entity, and differences in the segments' measurement practices between periods.

Revenue Test

Segment revenue (unaffiliated and intersegment) is at least 10% of the combined revenue (unaffiliated and intersegment) of all operating segments.

Profit and Loss Test

The absolute amount of segment profit or loss is at least 10% of the greater, in absolute amount, of:

1. Combined profits of all operating segments reporting a profit
2. Combined losses of all operating segments reporting a loss.

ASC 280-10-55 clarifies that, if the CODM uses different measures of profit or loss to evaluate the performance of different segments (e.g., net income versus operating income), the reporting entity is to use a single, consistent measure for the purposes of this profit and loss test. This does not, however, affect the requirement that the reporting entity disclose the measure of profit or loss used by the CODM for the purposes of decision making regarding the segment's performance and resources to be allocated to the segment.

Assets Test

Segment assets are at least 10% of the combined assets of all operating segments. Segment assets include those assets used exclusively by the segment and the allocated portion of assets shared by two or more segments. Assets held for general corporate purposes are not assigned to segments.

Comparability

Interperiod comparability must be considered in conjunction with the results of the 10% tests. If a segment fails to meet the tests in the current reporting period but has satisfied the tests in the past and is expected to in the future, it is considered as being reportable in the current year for the sake of comparability. Similarly, if a segment which rarely passes the tests does so in the current year as the result of an unusual event, that segment may be excluded to preserve comparability.

75% Test

After the 10% tests are completed, a 75% test must be performed. (ASC 280-10-50-14) The combined external revenue of all reportable segments must be at least 75% of the combined unaffiliated revenue of all operating segments. If the 75% test is not satisfied, additional segments must be designated as reportable until the test is satisfied. The purpose of this test is to ensure that reportable segments account for a substantial portion of the entity's operations.

Aggregating Segments

Certain other factors must be considered when identifying reportable segments. Management may consider aggregating two or more operating segments if:

1. They have similar economic characteristics,
2. Aggregation is consistent with the objective and basic principles of ASC 280, and
3. The segments are similar in all of the following areas:
   1. The nature of the products and services
   2. The nature of the production processes
   3. The type of customer for their products and services
   4. The methods used to distribute their products or provide their services
   5. The nature of the regulatory environment.

(ASC 280-10-50-11)

This aggregation can occur prior to performing the 10% tests if management desires.

Management may optionally combine information on operating segments that do not meet any of the 10% tests to produce a reportable segment, but only if the segments being combined have similar economic characteristics and also share a majority of the five aggregation criteria listed above. (ASC 280-10-50-13)

Note that information about operating segments that do not meet any of the 10% thresholds may still be disclosed separately. (ASC 280-10-50-15) By utilizing the aggregation criteria and quantitative thresholds (10% tests) for determining reportable segments, ASC 280 uses what should be considered a modified management approach.

The number of reportable segments should not be so great as to decrease the usefulness of segment reporting. As a rule of thumb, FASB suggests that if the number of reportable segments exceeds ten, segment information may become too detailed. In this situation, the most closely related operating segments should be combined into broader reportable segments, again, however, subject to the objectives inherent in ASC 280's requirements. (ASC 280-10-50-18)

Refer to the “Alternative Statement of Financial Position Segmentation” section and the accompanying diagram that follows. It provides an example of the different components of a reporting entity used for various accounting and reporting purposes.

Transfer Pricing

Since segment revenue as defined by ASC 280 includes intersegment sales, transfer pricing becomes an issue. Rather than establishing a basis for setting transfer prices, FASB requires companies to use the same transfer prices for segment reporting purposes as are used internally. Since most segments are organizational profit centers, internal transfer prices would generally reflect market prices, but even if this is not the case, these same transfer prices must be used for segment disclosures.

Common Costs

Another issue in determining profit or loss is the allocation of common costs. Common costs are expenses incurred by the reporting entity for the benefit of more than one operating segment. Again, segment reporting is required to conform to internal management reporting. Accordingly, these costs are only allocated to a segment for external reporting purposes if they are included in the measure of the segment's profit or loss that is used internally by the CODM.

General Corporate Expense

Difficulties can arise in distinguishing common costs from general corporate expenses. General corporate expenses are not direct expenses from the point of view of any operating segment; they are incurred for the benefit of the corporation as a whole and cannot be reasonably attributed to any operating segment. Common costs, on the other hand, benefit two or more segments and can be allocated to those segments in a manner determined by management to support internal decision making by the reporting entity.

Corporate Assets

Similarly, only those assets that are included internally in the measure of the segment's assets used to make operating decisions are reported as assets of the segment in external financial reports. If management allocates amounts to segment profit or assets internally and those amounts are used by the CODM, then those amounts are to be allocated on a reasonable basis and disclosed.

Products and Services

Revenue from external customers for each product and service or each group of similar products and services is to be reported by the reporting entity unless impracticable. If deemed to be impracticable, disclose that fact. If the company's reportable segments have been organized around products and services, then this disclosure will generally not be required.

Geographic Areas

A reporting entity separately discloses revenues from external customers and long-lived assets attributable to its domestic operations and foreign operations. If the reportable segments have been organized around geographic areas, then these disclosures will generally not be required because they would be duplicative.

Domestic operations are those operations located in the reporting entity's home country that generate either unaffiliated or intersegment revenues. Foreign operations are similar operations located outside of the home country of the reporting entity. For the purposes of these disclosures, US reporting entities' operations in Puerto Rico are not considered to be foreign operations, although management is not precluded from voluntary disclosure regarding Puerto Rican operations. (ASC 280-10-55)

If the reporting entity functions in two or more foreign geographic areas, to the extent revenues or assets of an individual foreign geographic area are material, then separately disclose these amounts. In addition, disclosure is required of the basis for attributing revenue to different geographic areas. A geographic area is defined as an individual country. If providing this information is impracticable, disclose that fact.

Major Customers

If the reporting entity earns 10% or more of its revenue on sales to a single external customer, disclose that fact and the amount of revenue from each such customer. Also, disclose the segment making these sales. This disclosure provides information on concentrations of risk.

For the purpose of this disclosure, a group of customers under common control, such as subsidiaries of a common parent, is regarded as a single customer. Similarly the various agencies of a government are considered to be a single customer. An insuring entity (such as Blue Cross) is not considered to be the customer unless that entity (rather than the patient) controls the decision as to the doctor, type of service, etc.