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Financial reporting developments A comprehensive guide Segment reporting Accounting Standards Codification 280 Revised May 2017 To our clients and other friends Segment reporting continues to be an important element of financial reporting for public companies. While the requirements of ASC 280, Segment Reporting, have been effective for several years, segment disclosures continue to be a frequent area of emphasis in SEC staff comment letters. In these reviews, the SEC staff often challenges companies' determination of the chief operating decision maker and companies' conclusions on identifying and aggregating operating segments. Companies also are frequently challenged about the adequacy of their entity-wide disclosures with respect to products and services. A fundamental principal of ASC 280 is that a company's segment disclosures should be consistent with management's reporting structure. The objective is to allow users to \"see through the eyes of management\" a company's business. By highlighting the risks and opportunities that management views as important, the FASB believes that financial statement users will be better positioned to understand the public entity's performance, to assess its prospects for future net cash flows and to make more informed judgments about the entity as a whole. Based upon the comment process, it is clear the SEC staff also believes that disaggregation of financial information is a benefit to investors. As a result, they are often skeptical when companies aggregate operating segments that separately would provide meaningful information to investors. This publication provides our interpretive guidance and reflects our experience in practice with ASC 280 since its issuance in June 1997 as Statement 131. This eighth edition has been updated to include further clarifications and enhancements to our interpretive guidance. See Appendix D for further detail on the updates provided. In light of the most recent SEC staff public comments on segment reporting, we encourage public companies to continue to challenge their segment reporting practices, especially in situations in which an entity has undertaken a reorganization or when there are inconsistencies between an entity's management reporting structure and its segment disclosures. Ernst & Young professionals are prepared to help you identify and understand the issues related to segment reporting. May 2017 Contents 1 Scope and overview ................................................................................................... 1 1.1 Competitive harm .................................................................................................................. 3 1.2 Operating segments............................................................................................................... 3 1.3 Aggregation criteria ............................................................................................................... 4 1.4 Reportable segments ............................................................................................................. 5 1.5 Annual disclosure requirements.............................................................................................. 5 1.5.1 First-level disclosures .................................................................................................... 6 1.5.1.1 Segment profit or loss and related information .............................................. 6 1.5.1.2 Segment assets .......................................................................................... 7 1.5.1.3 Reconciliations ........................................................................................... 7 1.5.2 Entity-wide disclosures .................................................................................................. 8 1.5.2.1 Information about major customers .............................................................. 8 1.6 Interim disclosure requirements ............................................................................................. 8 1.7 SEC considerations (updated May 2017) ................................................................................. 8 1.8 Transition for initial adoption of ASC 280 ................................................................................ 9 2 Operating segments ................................................................................................. 10 2.1 Determination of operating segments ................................................................................... 10 2.1.1 Engages in business activities ...................................................................................... 11 2.1.2 Operating results are regularly reviewed by the CODM to allocate resources and assess performance .............................................................................. 12 2.1.3 Discrete financial information is available ..................................................................... 15 2.1.4 CODM uses multiple types of segment information........................................................ 16 2.2 Discontinued operations ....................................................................................................... 18 2.3 Unconsolidated businesses ................................................................................................... 19 2.3.1 Inclusion of separate financial statements of an unconsolidated business ....................... 19 2.4 Reportable segments of public subsidiaries ........................................................................... 20 2.5 Goodwill considerations........................................................................................................ 20 3 Reportable segments ............................................................................................... 22 3.1 Aggregation criteria ............................................................................................................. 23 3.1.1 Consistent with the objective and basic principles of ASC 280 ....................................... 25 3.1.2 Economic characteristics ............................................................................................. 25 3.1.3 Qualitative characteristics ........................................................................................... 27 3.2 Determining amounts included in segment measures for the quantitative threshold tests ........ 29 3.2.1 Operating segment accounting principles ..................................................................... 30 3.2.2 Allocations to operating segments ............................................................................... 30 3.2.3 CODM uses more than one measure of segment profit/loss or segment assets ............... 31 3.2.4 CODM uses different measures for different segments .................................................. 31 3.2.5 Changes in segment measurements ............................................................................. 32 3.3 Quantitative thresholds ........................................................................................................ 32 3.3.1 Revenues ................................................................................................................... 33 Financial reporting developments Segment reporting | i Contents 3.3.2 Profit or loss ............................................................................................................... 34 3.3.2.1 Use of a consistent measure of profit or loss ............................................... 35 3.3.2.2 Aggregation may change reportable segments ............................................ 35 3.3.3 Assets ........................................................................................................................ 37 3.4 Combination of operating segments that do not meet quantitative thresholds......................... 37 3.5 Meeting the \"75%\" of consolidated revenue test .................................................................... 38 3.6 Determining whether an equity method investment is a reportable segment ........................... 39 3.7 The \"all other\" category ....................................................................................................... 40 3.8 Change in the quantitative thresholds from year to year ........................................................ 41 3.9 Number of reportable segments ........................................................................................... 41 4 Segment disclosure requirements ............................................................................. 43 4.1 Disclosure of segment profit or loss and segment assets ........................................................ 44 4.1.1 What is required to be disclosed ................................................................................... 46 4.1.2 What is not required to be disclosed ............................................................................. 46 4.1.3 Non-GAAP measures (updated May 2017) ................................................................... 47 4.1.4 CODM uses more than one measure of segment profit/loss or segment assets ............... 47 4.1.5 Materiality .................................................................................................................. 49 4.1.6 Interest ...................................................................................................................... 50 4.1.7 Segment assets .......................................................................................................... 51 4.2 Explanation of measurements .............................................................................................. 51 4.3 Reconciliations .................................................................................................................... 53 4.4 Disclosures and reconciliations related to equity method investments..................................... 54 4.5 Interim period information.................................................................................................... 54 4.6 Changes in reportable segments ........................................................................................... 56 4.6.1 Interim restatement .................................................................................................... 57 4.6.2 Timing of a change in segment reporting ...................................................................... 57 5 Entity-wide disclosures ............................................................................................ 59 5.1 Information about products and services............................................................................... 60 5.2 Information about geographic areas ..................................................................................... 61 5.2.1 Meaning of \"material\" ................................................................................................. 62 5.2.2 Revenues from external customers .............................................................................. 62 5.2.3 Long-lived assets ........................................................................................................ 62 5.3 Information about major customers ...................................................................................... 63 5.4 Restatement of entity-wide disclosures ................................................................................. 64 5.5 SEC disclosure rules ............................................................................................................. 64 6 Industry supplements............................................................................................... 65 6.1 Introduction ........................................................................................................................ 65 6.2 Banking and capital markets ................................................................................................. 65 6.2.1 Operating segments .................................................................................................... 65 6.2.2 Reportable segments .................................................................................................. 66 6.2.3 Entity-wide disclosures ................................................................................................ 66 6.3 Insurance ............................................................................................................................ 67 6.3.1 Operating segments .................................................................................................... 67 6.3.2 Aggregation criteria .................................................................................................... 67 6.3.3 Measurements used in segment disclosures.................................................................. 69 6.3.4 Scope ......................................................................................................................... 69 Financial reporting developments Segment reporting | ii Contents 6.4 Retail .................................................................................................................................. 69 6.4.1 General considerations ................................................................................................ 69 6.4.2 Aggregation considerations ......................................................................................... 70 6.4.3 Geographic segments in the same country ................................................................... 71 6.4.4 Credit operations ........................................................................................................ 71 6.4.5 Real estate operations................................................................................................. 71 6.5 Real estate .......................................................................................................................... 72 6.6 Health ................................................................................................................................. 73 6.6.1 Scope ......................................................................................................................... 73 6.6.2 Determining operating segments ................................................................................. 73 6.6.3 Segment disclosures ................................................................................................... 73 6.6.4 Entity-wide disclosures ................................................................................................ 73 6.7 Oil and gas........................................................................................................................... 73 6.8 Telecommunications ............................................................................................................ 74 7 Comprehensive example........................................................................................... 76 A Diagram to determine segments .............................................................................. A-1 B Abbreviations used in this publication ...................................................................... B-1 C Index of ASC references in this publication ............................................................... C-1 D Summary of important changes ............................................................................... D-1 Financial reporting developments Segment reporting | iii Contents Notice to readers: This publication includes excerpts from and references to the FASB Accounting Standards Codification (the Codification or ASC). The Codification uses a hierarchy that includes Topics, Subtopics, Sections and Paragraphs. Each Topic includes an Overall Subtopic that generally includes pervasive guidance for the topic and additional Subtopics, as needed, with incremental or unique guidance. Each Subtopic includes Sections that in turn include numbered Paragraphs. Thus, a Codification reference includes the Topic (XXX), Subtopic (YY), Section (ZZ) and Paragraph (PP). Throughout this publication references to guidance in the codification are shown using these reference numbers. References are also made to certain pre-codification standards (and specific sections or paragraphs of pre-Codification standards) in situations in which the content being discussed is excluded from the Codification. This publication has been carefully prepared but it necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decisions. Portions of FASB publications reprinted with permission. Copyright Financial Accounting Standards Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116, U.S.A. Portions of AICPA Statements of Position, Technical Practice Aids, and other AICPA publications reprinted with permission. Copyright American Institute of Certified Public Accountants, 1211 Avenue of the Americas, New York, NY 10036-8775, USA. Copies of complete documents are available from the FASB and the AICPA. Financial reporting developments Segment reporting | iv 1 Scope and overview Excerpt from Accounting Standards Codification Segment Reporting Overall Scope and Scope Exceptions 280-10-15-2 The guidance in the Segment Reporting Topic applies to all public entities, with certain exceptions noted below. Entities other than public entities are also encouraged to provide the disclosures described in this Subtopic. 280-10-15-3 The guidance in this Subtopic does not apply to the following entities: a. Parent entities, subsidiaries, joint ventures, or investees accounted for by the equity method if those entities' separate company statements also are consolidated or combined in a complete set of financial statements and both the separate company statements and the consolidated or combined statements are included in the same financial report. However, this Subtopic does apply to those entities if they are public entities and their financial statements are issued separately. b. Not-for-profit entities (regardless of whether the entity meets the definition of a public entity as defined above). c. Nonpublic entities. Glossary 280-10-20 Public Entity A business entity or a not-for-profit entity that meets any of the following conditions: a. It has issued debt or equity securities or is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets). b. it is required to file financial statements with the Securities and Exchange Commission (SEC). c. It provides financial statements for the purpose of issuing any class of securities in a public market. The segment reporting requirements apply only to public entities, as defined above, which includes companies making filings with a regulatory agency in preparation for the sale of securities in a public market (e.g., an initial public offering). Although they are not required to apply ASC 280, certain nonpublic entities and not-for-profit entities are encouraged to provide the disclosures described therein. In addition to the consolidated financial statements, some entities present in their annual reports additional information such as \"separate company\" financial statements of the parent entity, subsidiaries, joint ventures or equity method investees. ASC 280 does not apply to those entities' separate company financial statements. However, if the subsidiaries are public entities themselves (as defined in ASC 280), ASC 280 still applies to the separate financial statements of the public subsidiaries. See section 2.3 for further discussion of unconsolidated businesses. Financial reporting developments Segment reporting | 1 1 Scope and overview Excerpt from Accounting Standards Codification Segment Reporting Overall Objectives General 280-10-10-1 The objective of requiring disclosures about segments of a public entity and related information is to provide information about the different types of business activities in which a public entity engages and the different economic environments in which it operates to help users of financial statements do all of the following: a. Better understand the public entity's performance b. Better assess its prospects for future net cash flows c. Make more informed judgments about the public entity as a whole. Overview and Background General 280-10-05-3 A public entity could provide complete sets of financial statements that are disaggregated in several different ways, for example, by products and services, by geography, by legal entity, or by type of customer. However, it is not feasible to provide all of that information in every set of financial statements. The guidance in this Subtopic requires that general-purpose financial statements include selected information reported on a single basis of segmentation. The method for determining what information to report is referred to as the management approach. The management approach is based on the way that management organizes the segments within the public entity for making operating decisions and assessing performance. Consequently, the segments are evident from the structure of the public entity's internal organization, and financial statement preparers should be able to provide the required information in a cost-effective and timely manner. ASC 280 requires public entities to disclose certain information about reportable operating segments in complete sets of financial statements of the entity and in condensed financial statements of interim periods. It also requires public entities to present certain \"entity-wide\" information, including revenues related to products and services and geographic areas in which they operate. Information about major customers also is required. A public entity also is required to present disaggregated information by segment using the management approach. The objective of this approach is to allow users to see the company's business through the eyes of management based upon the way management reviews performance and makes decisions. The management approach requires segment information to be reported based on how management internally evaluates the operating performance of the company's business units or segments (i.e., its management reporting structure). The FASB believes users consider the management approach to be preferable for many reasons, including the following: 1) The management approach is based on an entity's internal organization, which is valuable because it highlights the risks and opportunities that management believes are important and allows users to assess the performance of individual operating segments in the same way that management reviews performance and makes decisions. 2) The management approach provides users with the opportunity to see the entity from management's vantage point and enhances users' ability to predict actions or reactions of management that can significantly affect the entity's prospects for future cash flows. Financial reporting developments Segment reporting | 2 1 Scope and overview 3) Because the information is already generated for management's use, the incremental cost of reporting segment information should be relatively low. Other than some of the entity-wide disclosures (see chapter 5 for a discussion of these disclosure requirements), management should not need to prepare any new reports to comply with the segment disclosure requirements. 4) Segment reporting under the management approach is consistent with other significant sections of an entity's annual report, such as the business review section and the chairman's letter. These sections of the annual report usually describe the company's businesses the way that management views and runs these businesses, which is how segment information is presented under the management approach. 1.1 Competitive harm Certain entities have expressed concern that making disclosures under the management approach may put them at a competitive disadvantage. Some entities believe that disclosing this information could affect their bargaining position in negotiations. Others believe that because some competitors may not have to make the same disclosures, the competitors will have a strategic advantage. Competitors may not have similar disclosures because their organizations are managed differently, resulting in different reportable segments, or because they are nonpublic or foreign and reporting under a framework that doesn't require similar segment reporting. ASC 280 does not provide a \"competitive harm\" exemption for providing segment information because the FASB was concerned that such an exemption might be overused. The SEC staff has stated that some registrants have contended that they should not be required to apply a US GAAP standard because the result would be \"competitively harmful\" or \"misleading.\" The staff stated that these arguments are troubling as they disregard the thoughtful balance taken by the accounting standard setters in crafting reporting standards that provide transparent, useful information to investors.1 As such these concerns do not provide a rationale to not provide the disclosures required by ASC 280. 1.2 Operating segments Excerpt from Accounting Standards Codification Segment Reporting Overall Overview and Background General 280-10-05-4 The management approach facilitates consistent descriptions of a public entity in its annual report and various other published information. It focuses on financial information that a public entity's decision makers use to make decisions about the public entity's operating matters. The components that management establishes for that purpose are called operating segments. While the concept of operating segments is fundamental to segment reporting, the identification of operating segments often is one of the biggest challenges in applying ASC 280. To properly determine the operating segments, the first step is to identify the entity's chief operating decision maker (CODM). The term CODM identifies the decision making role within an organization and not necessarily an individual with a specific title. Often the CODM of an entity is its chief executive officer or chief operating officer, but it may be a group of executives. The CODM is the individual or individuals within the organization who evaluate an entity's operating results to assess performance and allocate resources. The focus on \"operating results\" (e.g., revenues, margin, etc.) is consistent with the concept in ASC 280-10-05-4 regarding making decisions about the entity's operating matters. Consideration should be given to the 1 See speech made by SEC Deputy Chief Accountant Wesley R. Bricker, Office of the Chief Accountant, at the 2015 AICPA National Conference on Current SEC and PCAOB Developments. Financial reporting developments Segment reporting | 3 1 Scope and overview measures used by the CODM to allocate resources. Once the CODM is identified, an entity will be able to determine its operating segments. ASC 280 defines an operating segment as a component of a business entity that has each of the three following characteristics: 1) The component engages in business activities from which it may earn revenues and incur expenses (including start-up operations and revenues and expenses relating to transactions with other components of the same entity). 2) The operating results of the component are regularly reviewed by the entity's CODM to assess the performance of the individual component and make decisions about resources to be allocated to the component. 3) Discrete financial information about the component is available. For many entities, application of these three characteristics clearly will identify their operating segments. If the CODM assesses performance and makes resource allocation decisions based on only one type of segment information (e.g., products or services, geographic), the components reflected by that type of information constitute the operating segments of the entity. However, in some cases, the CODM may assess performance based on more than one type of operating result. For example, the CODM may review one type of results based on product lines and another type based on geographic area. In those situations, segment information is required to be presented for the type for which there are segment managers that are held accountable. If both types of segments have managers that are held accountable to the CODM, the types of segments based on products or services would be disclosed. 1.3 Aggregation criteria ASC 280 permits operating segments to be aggregated for reporting purposes even though they may be individually material, if (1) aggregation is consistent with the objective and basic principles of ASC 280, (2) the operating segments have similar economic characteristics (e.g., comparable long-term average gross margin), and (3) the operating segments are similar in each (i.e., all) of the following areas: The nature of the products or services The nature of the production processes The type or class of customer for their products or services The methods used to distribute their products or provide their services If applicable, the nature of the regulatory environment (e.g., banking, insurance) Illustration 1-1: Aggregation Assume a retailer has eight stores, each of which meets the definition of an operating segment and each of which is similar in each of the five areas listed above. If each store also has similar economic characteristics and aggregation would be consistent with the objective and basic principles of ASC 280, the stores can be aggregated into one reportable segment. However, if there were differences between the stores, such as demographics (which generally would affect the economic characteristics of the markets), aggregation might not be allowed even if all of the other criteria were met. In our experience, we have noted that the SEC staff often questions whether aggregation of operating segments into one or just a few reportable segments is consistent with the objective and basic principles of ASC 280. In evaluating the aggregation of operating segments, the SEC staff presumes that investors would prefer receiving disaggregated information about the operating segments. In addition, the SEC staff often requires registrants to provide historical and forecasted economic measures such as sales growth, Financial reporting developments Segment reporting | 4 1 Scope and overview gross margins, operating margins and any additional financial information to help the SEC staff assess whether individual operating segments are economically similar. ASC 280 does not prescribe a specific threshold for economic similarity and therefore there is no bright line when making this evaluation. However, the greater the percentage difference, the more evidence the company should have to support economic similarity of its operating segments. The SEC staff has stated that the aggregation criteria are intended to be a high hurdle2 and should be viewed from the perspective of investors. 1.4 Reportable segments Unless the aggregation criteria described in section 1.3 above, and in greater detail in section 3.1, are met, a public entity is required to report each material operating segment. The materiality thresholds for reporting individual or aggregated operating segments are based on exceeding 10% or more of segment revenues, segment absolute profit or loss, or segment assets. If any individual or properly aggregated operating segments do not meet the materiality thresholds, ASC 280 permits two or more of these immaterial operating segments to be combined into a single reportable segment if (1) combination is consistent with the objective and basic principles of ASC 280, (2) the operating segments have similar economic characteristics (e.g., comparable long-term average gross margin) and (3) the operating segments share a majority of the five specific aggregation criteria discussed in the preceding paragraphs. In addition, a public entity is required to report separate operating segments until the external revenue attributable to reportable segments is at least 75% of total consolidated revenue. For example, if an entity identifies four operating segments that have combined revenues of 60% of total consolidated revenue, the entity must disclose additional operating segments (even if they do not individually meet the quantitative thresholds) that have combined revenue of at least 15% of total consolidated revenue such that the reportable segments in the aggregate account for at least 75% of total consolidated revenue. 1.5 Annual disclosure requirements Excerpt from Accounting Standards Codification Segment Reporting Overall Overview and Background General 280-10-05-5 To provide some comparability between public entities, this Subtopic requires that an entity report certain information about the revenues that it derives from each of its products and services (or groups of similar products and services) and about the countries in which it earns revenues and holds assets, regardless of how the entity is organized. As a consequence, some entities are likely to be required to provide limited information that may not be used for making operating decisions and assessing performance. Other Presentation Matters General 280-10-45-1 This Subtopic does not require that a public entity report segment cash flow. However, paragraphs 280-10-50-22 and 280-10-50-25 require that a public entity report certain items that may provide an indication of the cash-generating ability or cash requirements of an entity's operating segments. 2 See speech made by SEC Deputy Chief Accountant Dan Murdock, Office of the Chief Accountant, at the 2014 AICPA National Conference on Current SEC and PCAOB Developments. Financial reporting developments Segment reporting | 5 1 Scope and overview 280-10-45-2 Nothing in this Subtopic is intended to discourage a public entity from reporting additional information specific to that entity or to a particular line of business that may contribute to an understanding of the entity. ASC 280 requires certain \"first-level\" disclosures (e.g., revenue by segment, a measure of profit or loss and assets by segment) for reportable segments (see chapter 4 for a discussion of these disclosure requirements), and additional \"entity-wide\" disclosures (e.g., revenues for the entire entity, organized by products and services and by geographic area) if such information is not subject to the first-level disclosures. Entity-wide disclosures are required regardless of whether that information is provided to or used by the CODM (see chapter 5 for a discussion of these disclosure requirements). ASC 280 requires segment information to be reported for each period for which a complete set of financial statements is provided and in condensed financial statements of interim periods. Also to ensure comparability, if there are changes in the composition of reportable segments in the current period, those changes are required to be retrospectively applied to earlier periods. However, restatement is not required when it is impracticable (i.e., when the necessary information is not available and the cost to develop it would be excessive). For example, restatement might not be practicable when a public entity undergoes a fundamental reorganization and redesigns its internal financial reporting system. Disclosure is required if an entity has changed its segment presentation as a result of a change in the composition of reportable segments. Furthermore, if the segment information for earlier periods is not restated because it is impractical, the entity must disclose current year segment information under both the old basis and new basis of segmentation unless such information is not available and impracticable to maintain. We note that the SEC staff views \"impracticable\" as a very high standard and often challenges registrants that do not recast prior year's segment information consistent with its segment reporting in the current year. As a result, companies should carefully evaluate whether it is impracticable to present comparable segment information for earlier periods as the SEC staff has an expectation that the information will be disclosed. 1.5.1 First-level disclosures ASC 280 requires that a public entity disclose the factors that management considers most significant in determining its reportable segments, such as differences in products or services, geographic areas of operations or regulatory environments. A public entity also must disclose the types of products and services generating revenues for each reportable segment. In addition to these general requirements, first-level disclosures include reported segment profit or loss and related information and segment assets. Adjustments and eliminations made in preparing a public entity's general-purpose financial statements and allocations of specific revenues, expenses, gains, losses and assets are included in the determination of segment amounts only if those items are included in the information provided to the CODM. For example, an entity that accounts for interest expense only on a consolidated basis (i.e., it is not included in the segment information) would not report interest expense for each reportable segment. Rather, the unallocated amount of interest expense, if material, would be separately reported in the reconciliation to consolidated amounts. 1.5.1.1 Segment profit or loss and related information Under ASC 280, a public entity reports segment profit or loss for each reportable segment based upon the performance measure provided to and used by the CODM for purposes of making decisions about allocating resources to the segment and assessing its performance. Therefore, the performance measure is company specific and may vary by company. Financial reporting developments Segment reporting | 6 1 Scope and overview ASC 280 requires certain components of segment profit or loss that are reported to the CODM to be separately reported for each reportable segment, including revenue, depreciation, interest revenue and expense, income taxes and significant noncash items. The segment information reporting in the footnotes should follow the same accounting policies used in generating the information used in the reports reviewed by the CODM even if those accounting policies are different from the ones used to prepare the consolidated financial statements. For example, First-In, First-Out (FIFO) basis may be used in reporting to the CODM and in the segment disclosures even though Last-In, First-Out (LIFO) is used in consolidation. Segment information also is not required to comply with GAAP. For example, pension expense might be reported on a cash basis to the CODM and in the segment disclosures though appropriate pension accounting would be required in the consolidated financial statements. However, an entity is required to make certain disclosures regarding how it has measured segment profit or loss and segment assets if these measures differ from the basis used in the preparation of the consolidated financial statements. If the CODM uses more than one measure of a segment's profit or loss and more than one measure of a segment's assets, the reported measures should be those that management believes are determined in accordance with the measurement principles most consistent with those used in measuring the corresponding amounts in the consolidated financial statements. See section 3.2.3 for further discussion when there is more than one measure of segment profit/loss or segment assets. In addition, the SEC staff has advised that if a company measures segment profit or loss on a basis such as earnings before interest, taxes, depreciation and amortization (EBITDA), as permitted by ASC 280, the discussion of operating results in Management Discussion and Analysis (MD&A) should be balanced between the reported measures of segment profit or loss and consolidated net income or loss as determined in accordance with GAAP. If a company determines segment profitability on a basis that differs from GAAP measures, the SEC staff has indicated that the segment measure should not be presented in a manner that gives it greater authority or prominence than net income as reported in the GAAP financial statements. 1.5.1.2 Segment assets Under ASC 280, a public entity reports a measure of assets for each reportable segment for those assets that are included in the measure of the segment's assets provided to the CODM. If no asset information is provided for a reportable segment, disclosure of segment assets is not required, but that fact and the reason for its exclusion should be disclosed. In addition, an entity is required to disclose its equity investments and capital expenditures if these items are included in the measure of segment assets reviewed by the CODM. 1.5.1.3 Reconciliations Under ASC 280, a public entity is required to provide a reconciliation of: the total of the reportable segments' profit or loss to the consolidated income before income taxes and discontinued operations (if an entity allocates these items to segments, the entity may reconcile to income or loss after these items) the total of the reportable segments' revenues to the entity's consolidated revenues the total of the reportable segments' assets to the entity's consolidated assets; and the total of the reportable segments' amounts for every other significant item of information disclosed to the corresponding consolidated amount. Significant reconciling items should be disclosed separately. Financial reporting developments Segment reporting | 7 1 1.5.2 Scope and overview Entity-wide disclosures Although ASC 280 requires a management approach, certain additional information must be disclosed even if that information is not provided to or used by the CODM to manage the public entity. For example, if an entity is not managed based on differences in products or services (e.g., a geographical approach is used), certain information about products or services is nonetheless required to be disclosed. On the other hand, if a public entity manages its world-wide operations based on differences in products or services, certain geographic information nonetheless must be disclosed. The amounts reported should be based on the financial information used to produce the public entity's general-purpose financial statements. If providing entity-wide disclosures is impracticable (which is expected to be rare), the disclosures are not required, but that fact and the reason should be disclosed. 1.5.2.1 Information about major customers ASC 280 requires all public entities to provide information about reliance on major customers (i.e., external customers that represent 10% or more of the public entity's revenue), even if such entities operate in only one segment. To the extent the disclosures coincide with disclosures required in other ASC Topics (e.g., ASC 275) the disclosures could be combined. For example, the disclosures under ASC 275 on the description of products and services and concentration in volume of business transacted with a particular customer could be integrated with the disclosures regarding segments. 1.6 Interim disclosure requirements ASC 280 requires selected segment information to be reported on an interim basis. The disclosures include information on revenues, profit or loss, total assets for which there has been a material change from the amount disclosed in the last annual report, differences since year end in the measurement of segment profit or loss and a reconciliation of combined segment profit or loss to consolidated income (before income taxes and discontinued operations, unless these items are already allocated to individual segments). This information must be disclosed in the condensed financial statements included in a registrant's Form 10-Q. Entity-wide disclosures are not required for interim reporting purposes. Consistent with annual reporting, segment information for earlier periods is restated (unless impracticable) when an entity changes the composition of its reportable segments. 1.7 SEC considerations (updated May 2017) The SEC staff has continued to focus on segment disclosures and the application of ASC 280. At the 2016, 2015 and 2014 AICPA National Conference on Current SEC and PCAOB Developments,3 SEC staff members have discussed their approach in its review of segment disclosures and encouraged registrant's to adopt a similar mindset when evaluating the appropriateness of segment disclosures. Some of the areas highlighted by the SEC staff included (1) identification of the CODM, (2) identification of operating segments, (3) the aggregation or combination of operating segments, (4) internal controls over segment reporting and (5) use of non-GAAP measures. SEC representatives said that segment reporting continues to be a critical focus area because investors continue to identify it as the most important disclosure area in SEC filings. 3 See speech made by SEC Deputy Chief Accountant Dan Murdock, Office of the Chief Accountant, at the 2014 AICPA National Conference on Current SEC and PCAOB Developments, speech made by SEC Professional Accounting Fellow Courtney D. Sachtleben, Office of the Chief Accountant, at the 2015 AICPA National Conference on Current SEC and PCAOB Developments and 2016 AICPA National Conference on Current SEC and PCAOB Developments, Compendium of significant accounting and reporting issues. Financial reporting developments Segment reporting | 8 1 Scope and overview The SEC staff stated that they have been working closely with the PCAOB to emphasize the objectives and principles outlined in the guidance on segment reporting, including whether the design and operation of internal controls over the segment reporting judgments are appropriate. The SEC staff highlighted that the guidance on segment reporting requires the application of reasonable judgment and that input from, and interaction with, the CODM may be an important element in the design of effective internal controls over financial reporting, specifically how the CODM allocates resources and assesses performance. Documenting the design and effective operation of management's controls over these judgments is an integral part of management's support for the effectiveness of its internal controls over financial reporting and will be essential to the auditor's ability to evaluate these controls. The following sections highlight recent remarks from the SEC staff: Identification of the CODM see section 2.1.2 Identification of operating segments see section 2.1 Aggregation of operating segments see section 3.1 Non-GAAP measures see section 4.1.3 We continue to see the SEC staff expand its review of publicly available information about registrants beyond the information included in public filings, including content from earnings calls, registrant websites and industry or analyst presentations. The review of additional information seems focused on identifying any potential inconsistencies between the way in which management describes its business to the public and the information contained in the company's segment footnote. The SEC staff often requests that registrants explain any potential inconsistencies between the information that is available elsewhere in the public domain and the information included in the segment footnote. In light of the SEC staff's continued focus on segment reporting, we encourage public companies to continue to challenge their segment reporting practices, including the design and operation of their internal controls over financial reporting. 1.8 Transition for initial adoption of ASC 280 For entities that have not previously applied the provisions of ASC 280 (that is, non-public entities or notfor-profit entities that voluntarily adopt or become required to adopt ASC 280), the segment disclosures are required for all years presented in the entity's financial statements, unless it is impracticable to prepare prior year information. Financial reporting developments Segment reporting | 9 2 Operating segments 2.1 Determination of operating segments Excerpt from Accounting Standards Codification Segment Reporting Overall Disclosure Operating Segments 280-10-50-1 An operating segment is a component of a public entity that has all of the following characteristics: a. It engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same public entity). b. Its operating results are regularly reviewed by the public entity's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance. c. Its discrete financial information is available. 280-10-50-2 An operating segment shall include components of a public entity that sell primarily or exclusively to other operating segments of the public entity if the public entity is managed that way. Information about the components engaged in each stage of production is particularly important for understanding vertically integrated public entities in certain businesses, for example, oil and gas entities. This information is also important because different activities within the entity may have significantly different prospects for future cash flows. 280-10-50-3 An operating segment may engage in business activities for which it has yet to earn revenues, for example, start-up operations may be operating segments before earning revenues. 280-10-50-4 Not every part of a public entity is necessarily an operating segment or part of an operating segment. For example, a corporate headquarters or certain functional departments may not earn revenues or may earn revenues that are only incidental to the activities of the public entity and would not be operating segments. For purposes of this Subtopic, a public entity's pension and other postretirement benefit plans are not considered operating segments. 280-10-50-5 The term chief operating decision maker identifies a function, not necessarily a manager with a specific title. That function is to allocate resources to and assess the performance of the segments of a public entity. Often the chief operating decision maker of a public entity is its chief executive officer or chief operating officer, but it may be a group consisting of, for example, the public entity's president, executive vice presidents, and others. Financial reporting developments Segment reporting | 10 2 Operating segments Pending content: In May 2014, the FASB issued ASC 606, Revenue from Contracts with Customers, which replaces most existing revenue recognition guidance and interpretations. It also issued consequential amendments (included in Accounting Standards Update (ASU) 2014-09) to ASC 280-10-50-1 through 50-4 where the word \"earn\" was replaced with the word \"recognize.\" This amendment does not change the segment reporting requirements under ASC 280. The amendment is effective for annual reporting periods beginning after December 15, 2017 for public companies and December 15, 2018 for non-public companies. The determination of an entity's operating segments is the first step in determining what segment information needs to be reported in the entity's financial statements and is often the primary focus of the SEC staff in the review of an entity's segment disclosures. ASC 280 says individual business components are operating segments if they meet all of the following criteria: It engages in business activities from which it may earn revenues and incur expenses (section 2.1.1). Its operating results are regularly reviewed by the public entity's CODM to allocate resources and assess performance (section 2.1.2). Its discrete financial information is available (section 2.1.3). Sometimes, application of the guidance will result in identification of a single operating segment. In such circumstances, management should carefully evaluate whether its conclusion is consistent with the guidance and the way in which the company presents itself to investors. For example, the SEC staff has cautioned that it would seem counter to the objectives of segment reporting if the entity's business description indicates the entity is diversified across businesses or products, yet is not managed in a disaggregated way.4 See chapter 4 for disclosure considerations when an entity is organized as a single operating segment. 2.1.1 Engages in business activities To be an operating segment, a component engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same public entity). Certain functional departments that do not earn revenues or that earn revenues that are incidental to the entity's activities would not be operating segments. Corporate headquarters, corporate shared services and centralized treasury operations generally would not qualify as operating segments. Conversely, a division that earns revenues, even if its revenues are all intercompany revenues, as might be the case in a vertically integrated operation (such as in the extractive industry) might be an operating segment. In certain circumstances a division that only performs research and development activities might be considered an operating segment if there is discrete financial information available and the operating results are reviewed regularly by the CODM (as discussed further below). Even a start-up operation that has not yet earned revenues may meet the requirement of engaging in business activities. Further, ASC 280 does not preclude such a division from being a reportable segment if management believes the additional information may contribute to a better understanding of the entity, even if the revenues are considered incidental (ASC 280-10-55-3 and 55-4). 4 See speech made by SEC Professional Accounting Fellow Courtney D. Sachtleben, Office of the Chief Accountant, at the 2015 AICPA National Conference on Current SEC and PCAOB Developments. Financial reporting developments Segment reporting | 11 2 Operating segments Components that earn revenues and incur expenses are not required to have assets to be considered operating segments. The focus of the criterion is whether the component engages in business activities from which it may earn revenues and incur expenses provided it otherwise meets the definition of an operating segment. For example, Division A, which meets the ASC 280 definition of an operating segment, leases assets from Division B. The leased assets are presented in the internal financial reports of Division B. In this case, Division A is an operating segment despite the fact that no assets are allocated to it. However, if no asset information is provided for a reportable segment, that fact and the reason for it should be disclosed (ASC 280-10-55-5 and 55-6). 2.1.2 Operating results are regularly reviewed by the CODM to allocate resources and assess performance To be an operating segment, the operating results of the component are regularly reviewed by the public entity's CODM in order to assess the performance of the individual segment and make decisions about resources to be allocated to the segment. That is, the CODM makes key operating decisions based on financial information for the component. Identification of the CODM The term \"chief operating decision maker\" defines a function rather than an individual with a specific title. The function of the CODM is to allocate resources to and assess the operating results of the operating segments of an entity and may not necessarily be the individual responsible for strategic decisions or the individual who has ultimate decision-making authority. It is important to think about what the key operating decisions are and who is making those decisions for the entity to properly identify the CODM. Often, an entity's CODM is its chief executive officer or chief operating officer, but the CODM also could be a group consisting of top executives (e.g., a management committee or the executive committee of the board of directors). The SEC staff has encouraged registrants to take a fresh look at their CODM determination and not default to the entity's CEO. Identifying the CODM is critical to the evaluation of operating segments because it is the information used by the CODM for purposes of allocating resources and assessing performance that would provide the basis for determining the operating segments. The function of the CODM is to allocate resources and assess performance for each segment but not necessarily how these resources are allocated within the individual segments. For example, the CODM may assess the performance of and allocate resources to an operating segment but delegate the allocation of those resources within the operating segment to the segment manager. In most circumstances, the identification of the CODM is rather straightforward based upon clearly defined operational and reporting protocols of the organization. However, the determination of an entity's CODM may be more difficult when the organizational structure of the entity is complex. Consider the following illustration: Financial reporting developments Segment reporting | 12 2 Illustration 2-1: Operating segments Identification of the CODM Assume that a public entity has a president, a chief executive officer and a chief operating officer and that these positions are held by different individuals. Also assume that all three of these individuals serve on a management committee, which exists to make operating decisions related to the operating segments of the entity, and that each has an equal vote in decisions made by the committee. In this case, the CODM would be the management committee because the committee, which is evenly controlled by its members, makes the operating decisions rather than any individual executive. Thus, the internal financial information that is provided to the members of the management committee in order to make operating decisions and assess performance would constitute the operating segment information. While the CODM may be a committee, it is important to note that the mere existence of a management committee does not necessarily mean that the management committee is the CODM. We believe the FASB intended to include the management committee concept for situations in which executives were, in effect, sharing decision making authority in an entity. When a management committee is used as a mechanism to provide input to the chief executive officer, the chief executive officer would be the CODM if he/she is responsible for assessing performance and making the key operating decisions. However, if the management committee is the level at which the key operating decisions are made, then the management committee may be the CODM. In these circumstances, it's important to understand the relationship and interaction between the management committee and the level at which the key operating decisions are being made. The CODM's assessment of performance and allocation of resources The periodic financial reporting package provided to the CODM provides insight into how management has organized the company for purposes of making operating decisions and assessing performance. Historically, the SEC staff has placed emphasis on the financial information included in the reporting package reviewed by the CODM, with the presumption that if information was included in the reporting package provided to the CODM, it must be used by the CODM to assess performance and allocate resources. However, a company must assess how that financial information is being used by the CODM in making key operating decisions, and the SEC staff has stated that inclusion of information in a reporting package should not be the only factor considered in the analysis.5 Although it's important to consider the financial information available and used by the CODM when identifying an entity's operating segments, the level in which financial information is presented on a disaggregated basis in the reporting package given to the CODM is just one data point to consider in the determination of operating segments. That is, the lowest level of disaggregation presented in the CODM reporting package would not be determinative. Other factors to consider include the overall management structure (i.e., the organizational chart, including the roles and responsibilities of those who report directly to the CODM), how an organizational structure may have changed in recent years due to acquisitions, dispositions or changes in business strategy, the basis on which budgets and forecasts are prepared, and the basis for how executive compensation is determined (e.g., performance criteria underlying compensation plans). However, the SEC staff may continue to request the reporting package reviewed by the CODM, as well as the company's organizational structure, to understand how management makes operating decisions and assesses performance. Consider the following example: 5 See speech made by SEC Deputy Chief Accountant Dan Murdock, Office of the Chief Accountant, at the 2014 AICPA National Conference on Current SEC and PCAOB Developments and speech made by SEC Professional Accounting Fellow Courtney D. Sachtleben, Office of the Chief Accountant, at the 2015 AICPA National Conference on Current SEC and PCAOB Developments. Financial reporting developments Segment reporting | 13 2 Illustration 2-2: Operating segments Process for making key operating decisions Below is the reporting structure for a public entity: CODM Accessories Division Segment Manager Clothing Division Segment Manager Shoes Pants Shirts Watches Sporting Goods Segment Manager Equipment Souvenirs Assume that the six operating units (shoes, pants, shirts, watches, equipment and souvenirs) are grouped into three divisions (clothing, accessories and sporting goods) and that each of the three divisions has a segment manager who reports directly to the CODM. The CODM receives discrete financial information at both the division and component level every month. Even though the CODM receives discrete financial information for the six components, the company must assess how the CODM makes key operating decisions and at what level those decisions are made. The company determines that operating decisions are made at the division level by the CODM. For example, marketing strategies are determined by the CODM for each division, and each segment manager is responsible for deploying that strategy at the component level. Also, quarterly financial information is presented to the Board of Directors and investors at the division level, which is consistent with the level at which the CODM makes decisions. In addition, the company determines the following: Budgets and forecasts are prepared at the division level, and the CODM reviews budget-to-actual variances at that level on a monthly basis. The segment managers are compensated in accordance with the company's bonus plan, which sets targets for each division. Therefore, the company concludes that while the CODM receives financial information for the components, performance is assessed and resources are allocated at the division level so the three divisions are the operating segments. Some registrants have asserted that the component (the operating units in the example above) could not be an operating segment because the operating unit managers do not report directly to the CODM. The SEC staff routinely rejects such assertions when the CODM bases his/her decisions on the information provided at the component level (operating unit level) despite the absence of segment managers at that level. Rather, the registrant must demonstrate that the CODM does not use the individual component information received, but instead uses information at the more aggregated level (the division level