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Chief operating decision maker

What Is a Chief Operating Decision Maker?

A chief operating decision maker (CODM) is the individual or group within a public entity responsible for allocating resources allocation to the entity's operating segments and assessing their performance assessment. This concept is central to financial reporting under major accounting standards, falling under the broader category of accounting standards. The CODM's perspective dictates how an entity's operations are segmented for external reporting purposes, providing users of financial statements with insights into the entity's internal structure and how management evaluates its business.

History and Origin

The concept of the chief operating decision maker emerged from efforts to improve the relevance and usefulness of segment reporting. Prior to the adoption of the "management approach" to segment reporting, companies often presented segment information based on industry definitions, which did not always align with how management internally ran the business.

In the United States, the Financial Accounting Standards Board (FASB) introduced the CODM concept with the issuance of Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, in June 1997. This standard superseded previous guidance and significantly changed how U.S. public companies report segment information. FASB Statement No. 131 mandates that companies report information about operating segments based on the way management organizes segments for making operating decisions and assessing performance.21

Internationally, the International Accounting Standards Board (IASB) followed a similar approach with IFRS 8, Operating Segments, issued in November 2006, effective for annual periods beginning on or after January 1, 2009.20,19 IFRS 8 largely converged with FASB Statement 131, also adopting the management approach and emphasizing the role of the chief operating decision maker in identifying reportable segments.18,17 The aim was to align external disclosures with the internal information used by management, enhancing transparency for financial analysts and other stakeholders.

Key Takeaways

  • The chief operating decision maker is a function, not necessarily an individual with a specific title, responsible for resource allocation and performance assessment.
  • The CODM's internal reporting structure defines an entity's operating segments for external financial reporting.
  • Both U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) utilize the chief operating decision maker concept for segment disclosures.
  • Identifying the CODM is a critical first step in determining an entity's reportable segments.
  • The disclosures based on the CODM's view provide users with a "management's perspective" on the business.

Interpreting the Chief Operating Decision Maker

The identification of the chief operating decision maker is fundamental to understanding a public entity's segment reporting. This individual or group (which might be the chief executive officer, chief operating officer, or even the board of directors) reviews the operating results of various components of the business to make decisions regarding the allocation of resources and the evaluation of performance.16,15

The reported segment information, therefore, mirrors the internal management reports used by the CODM. This "management approach" provides external users with the same disaggregated information that top management uses to run the business. If the CODM uses multiple measures of a segment's profit or loss, the entity may report additional measures, but at least one reported measure should be consistent with the principles used in the entity's consolidated financial statements.14

Hypothetical Example

Consider "GlobalTech Inc.," a diversified technology company. The board of directors has designated the Chief Executive Officer (CEO) as the chief operating decision maker. The CEO receives monthly performance reports categorized by three distinct business lines: Software Solutions, Hardware Manufacturing, and Cloud Services. Each report includes revenues, direct expenses, and specific profitability metrics.

Based on these internal reports, the CEO makes decisions on budget allocations for research and development, marketing campaigns, and capital expenditures for each business line. Because the CEO, as the CODM, regularly reviews these three components, and discrete financial information is available for each, GlobalTech Inc. would likely identify Software Solutions, Hardware Manufacturing, and Cloud Services as its reportable operating segments in its external financial statements. This structure allows investors to see the profitability and resource allocation decisions from the same vantage point as GlobalTech's top management.

Practical Applications

The chief operating decision maker plays a pivotal role in shaping how an entity's financial performance is presented to the public. For instance, in its annual filings with the Securities and Exchange Commission (SEC), Amazon.com, Inc. identifies its operating segments as North America, International, and Amazon Web Services (AWS).13 These segments reflect how Amazon's management evaluates its business performance and manages its operations.

The CODM concept is crucial for:

  • Segment Disclosures: Publicly traded companies are required to disclose financial and descriptive information about their reportable segments, including measures of segment profit or loss and assets, often reflecting what the chief operating decision maker reviews internally.12,11
  • Resource Allocation Decisions: The information reviewed by the CODM directly influences strategic decisions about where to invest capital and deploy operational efforts across different parts of the business.
  • Investor Analysis: Investors and analysts rely on segment information to understand an entity's diverse business activities, evaluate the performance assessment of individual components, and assess prospects for future cash flows.
  • Regulatory Compliance: Adherence to standards like FASB ASC 280 (Segment Reporting) and IFRS 8 is monitored by regulatory bodies. The SEC, for example, issues Staff Accounting Bulletins (SABs) that reflect its views on the application of accounting principles, including those related to segment reporting.10

Limitations and Criticisms

While the chief operating decision maker approach aims to provide relevant and useful information, it does have limitations and has faced criticisms. One challenge lies in consistently identifying the CODM, as the function of resource allocation and performance assessment may not always reside with a single individual or clearly defined group. In complex organizational structures, especially those with matrix management, multiple sets of internal reports might exist, making the identification of the CODM and operating segments less straightforward.9

Another point of contention is the potential for management discretion in determining the CODM, which can influence the reported segments. While the goal is to reflect how management actually operates the business, some argue this could allow for a degree of flexibility that might not always serve the clarity desired by external users. For instance, sometimes the entire board of directors is identified as the CODM, even when executive and non-executive directors have distinct roles in corporate governance.8,7 However, accounting firms like BDO emphasize that the CODM function, rather than a specific title, is key, noting the need to challenge instances where the entire board is identified if it contradicts the functional role of resource allocation and performance assessment.6

Furthermore, the disclosed segment information often includes non-GAAP measures if those are what the CODM uses internally. While this offers insight into management's perspective, it can sometimes make direct comparisons between companies more challenging if different internal metrics are used.

Chief Operating Decision Maker vs. Segment Manager

While both roles are integral to an entity's organizational structure and segment reporting, the chief operating decision maker (CODM) and a segment manager serve distinct functions.

The chief operating decision maker is the function that makes fundamental decisions about the allocation of resources to the entity's operating segments and assesses the performance of those segments at the highest level. This function sets the strategic direction and oversees the overall business units from an operational standpoint. The CODM's view directly determines what constitutes an operating segment for financial reporting purposes, ensuring that reported information aligns with how the entity is managed internally.

A segment manager, on the other hand, is generally accountable to the CODM and is responsible for the day-to-day operations and financial results of a specific operating segment. The segment manager maintains regular contact with the CODM, discussing operational activities, financial results, forecasts, or plans for their segment. While a CODM might also be a segment manager for a particular segment, the segment manager's role is typically at a more granular, operational level, focusing on the execution within their assigned segment rather than the overarching strategic allocation across all segments.5

FAQs

Who typically fulfills the role of the chief operating decision maker?

The role of the chief operating decision maker can be performed by a single individual, such as the chief executive officer (CEO) or chief operating officer, or by a group, such as a committee of executive directors or the full board of directors. The key is the function they perform: allocating resources and assessing the performance of the entity's segments.4

Why is identifying the chief operating decision maker important for financial reporting?

Identifying the chief operating decision maker is crucial because it dictates how an entity's operating segments are identified and how financial information is reported for those segments. This "management approach" ensures that the external financial statements provide users with the same insights into the business that internal management uses for decision-making.3

What kind of information does the chief operating decision maker typically review?

The chief operating decision maker regularly reviews financial information such as revenues, expenses, profit or loss, and often assets, for each of the entity's operating segments. This information is used to make decisions about resource allocation and to assess each segment's individual performance. The exact metrics can vary but must be consistent with how management assesses the business internally.2

Does the chief operating decision maker have to be a single person?

No, the chief operating decision maker does not have to be a single person. It is defined as a function that can be carried out by an individual or a group of individuals. For example, a group comprising a company's president, executive vice presidents, and others might collectively serve as the CODM.1

How does the CODM affect the level of detail in segment disclosures?

The CODM's internal reporting structure and the level of detail they review directly influence the segment disclosures. Public entities are required to report information on the same basis that the CODM uses internally for evaluating segment performance and allocating resources. This means that if the CODM reviews detailed discrete financial information for many components, those details may be required in external segment reporting, subject to quantitative thresholds for reportable segments.