Reportable segments

Reportable segments are distinct components of a public entity for which separate financial information is available, and whose operating results are regularly reviewed by the chief operating decision maker (CODM) to make decisions about resource allocation and performance assessment, as defined by accounting standards within the broader field of financial accounting. They provide granular insight into a company's diverse operations, enabling stakeholders to understand its various business activities and the economic environments in which it operates. Publicly traded companies are required to disclose financial data for these reportable segments to offer greater transparency into their financial performance and strategic direction.

History and Origin

The requirement for segment reporting emerged from a growing need for more detailed information about diversified businesses. Early efforts in the U.S. to standardize segment disclosures began with the Accounting Principles Board (APB) Statement No. 2 in 1967, which called for supplemental information from diversified entities. This was followed by the Financial Accounting Standards Board (FASB) issuing Statement of Financial Accounting Standards (SFAS) No. 14, "Financial Reporting for Segments of a Business Enterprise," in December 1976, which mandated disclosure by industry segment and geographic area. SFAS 14 was effective for fiscal years beginning after December 15, 1976, and marked the first U.S. accounting standard to require disaggregated information.²⁶

However, SFAS 14 faced criticism for its lack of clear guidance on defining reportable segments and for allowing aggregation that could obscure sensitive proprietary information.²⁵ In response to these concerns and a demand from financial statement users and analysts for more granular data, the FASB superseded SFAS 14 with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," in June 1997. This new standard, now codified as Accounting Standards Codification (ASC) 280, adopted the "management approach." The management approach requires companies to report segment information on the same basis that management uses internally to assess performance and allocate capital, offering a "through the eyes of management" view.²⁴,²³ This framework has been a topic of continuous discussion, with the FASB issuing Accounting Standards Update (ASU) 2023-07 in November 2023 to further enhance disclosures about reportable segments, particularly concerning significant segment expenses.²²

Key Takeaways

• Reportable segments represent parts of a company for which separate financial data is reviewed by the Chief Operating Decision Maker (CODM).
• They are determined using the "management approach," reflecting how the company's own management evaluates its business units.
• Public entities must meet specific quantitative thresholds for revenue, profit or loss, or assets to be classified as reportable segments.
• Disclosures for reportable segments provide investors with a clearer picture of a company's diverse operations and the drivers of its financial performance.
• These disclosures are essential for investor relations, helping capital allocators assess prospects for future net cash flows and make informed judgments.

Interpreting the Reportable Segments

The identification and interpretation of reportable segments are crucial for understanding a company's operational structure and performance. A component of a public entity qualifies as an operating segment if it engages in business activities from which it may earn revenue and incur expenses, its operating results are regularly reviewed by the CODM, and discrete financial information is available for it.²¹

Once operating segments are identified, they are evaluated against specific quantitative thresholds to determine if they must be separately reported. An operating segment is considered a reportable segment if it meets any of the following 10% tests:

• Its reported revenue (including both external sales and intersegment sales) is 10% or more of the combined revenue of all operating segments.
• The absolute amount of its reported profit or loss is 10% or more of the greater of (a) the combined reported profit of all operating segments that did not report a loss, or (b) the combined reported loss of all operating segments that reported a loss.
• Its assets are 10% or more of the combined assets of all operating segments.²⁰,¹⁹

Even if an operating segment does not meet these quantitative thresholds, management may choose to report it separately if they believe the information is useful to users of the financial statements.¹⁸ Furthermore, the total external revenue reported by the reportable segments must constitute at least 75% of the entity's total consolidated revenue.¹⁷ If the 75% threshold is not met, additional operating segments must be identified as reportable segments until the threshold is satisfied. These disclosures help users better understand the public entity's overall performance and assess its prospects for future net cash flows.¹⁶

Hypothetical Example

Consider "Global Innovations Inc.," a diversified technology company. Its CODM reviews financial data for three distinct operating segments:

1. Software Solutions: Develops and sells enterprise software.
2. Hardware Manufacturing: Produces specialized electronic devices.
3. Consulting Services: Provides IT consulting and implementation services.

Here's a simplified breakdown of their financial data for the year:

Step 1: Calculate 10% thresholds:

• Revenue Threshold: 10% of total combined revenue ($1,050 million) = $105 million.
• Profit/Loss Threshold:
  • Combined profit of segments not reporting a loss: $120 (Software) + $10 (Consulting) = $130 million.
  • Combined loss of segments reporting a loss: $30 (Hardware) = $30 million.
  • The greater absolute amount is $130 million. 10% of $130 million = $13 million.
• Asset Threshold: 10% of total combined assets ($700 million) = $70 million.

Step 2: Identify Reportable Segments:

• Software Solutions:
  • Revenue ($600M) > $105M (reportable)
  • Profit ($120M) > $13M (reportable)
  • Assets ($450M) > $70M (reportable)
  • Conclusion: Software Solutions is a reportable segment.
• Hardware Manufacturing:
  • Revenue ($350M) > $105M (reportable)
  • Loss ($30M) > $13M (reportable)
  • Assets ($200M) > $70M (reportable)
  • Conclusion: Hardware Manufacturing is a reportable segment.
• Consulting Services:
  • Revenue ($100M) < $105M (not reportable based on revenue)
  • Profit ($10M) < $13M (not reportable based on profit/loss)
  • Assets ($50M) < $70M (not reportable based on assets)
  • Conclusion: Consulting Services is not a reportable segment based on quantitative thresholds.

Step 3: Check 75% Revenue Threshold for Reportable Segments:

• Reportable segments' external revenue:
  • Assume Software Solutions external revenue is $550M.
  • Assume Hardware Manufacturing external revenue is $300M.
  • Total reportable segment external revenue = $550M + $300M = $850M.
• Total consolidated revenue for Global Innovations Inc. is $950M (sum of external revenues from all segments).
• Percentage of consolidated revenue: ($850M / $950M) * 100% = 89.47%.
• Since 89.47% is greater than 75%, the threshold is met.

Global Innovations Inc. would be required to disclose separate financial information for its Software Solutions and Hardware Manufacturing reportable segments. Information for Consulting Services would typically be grouped into an "all other segments" category.

Practical Applications

Reportable segments play a vital role in providing actionable insights across various financial domains. In the realm of investing, segment disclosures allow investors and analysts to conduct more informed valuations and risk assessments. By examining the revenue, profitability, and assets of individual reportable segments, users can pinpoint which parts of a diversified company are driving growth or experiencing challenges. This granular data helps in understanding a company's underlying business model and its exposure to different markets or industries.

For market analysis, segment reporting enables industry-specific comparisons. Analysts can compare the performance of a company's segment to that of its pure-play competitors, providing a clearer picture of its competitive standing. This is particularly useful in industries undergoing rapid change or facing distinct economic environments.

From a regulatory perspective, the Securities and Exchange Commission (SEC) actively monitors compliance with segment reporting disclosure requirements. These regulations, primarily under ASC 280, ensure that public entities provide adequate information to the market, supporting fair and transparent financial reporting. For example, SEC Regulation S-K, Item 101(c), mandates a narrative description of the business, focusing on each reportable segment.¹⁵ The FASB's ongoing updates to ASC 280, such as ASU 2023-07, underscore the commitment to enhancing the quality and detail of these disclosures, responding to calls from investors for more specific information, especially concerning significant segment expenses.¹⁴

Limitations and Criticisms

While reportable segments enhance transparency, the "management approach" they employ has faced some criticisms. One concern is the potential for managerial discretion in identifying operating segments and applying aggregation criteria. Critics argue that this flexibility might allow management to present information in a way that conceals sensitive proprietary information or reduces comparability across firms.¹³,¹² The standard does not strictly define "similar economic characteristics" for aggregation, leaving room for subjective judgment.¹¹

Another limitation relates to the depth of disclosure. Historically, some concerns have been raised about insufficient data items for each segment, leading to a less complete picture for financial statement users.¹⁰ While recent FASB updates, particularly ASU 2023-07, aim to address this by requiring more detailed disclosure of significant segment expenses, the challenge of achieving perfect comparability and complete transparency remains.⁹

Furthermore, the allocation of common costs and assets to individual reportable segments can be complex and may involve estimates and arbitrary allocations, which could potentially mislead users if not clearly explained.⁸ This means that while segment reporting provides invaluable insights, users must exercise judgment and consider the context of how the segment data is prepared and presented.

Reportable Segments vs. Operating Segments

The terms "reportable segments" and "operating segments" are often used interchangeably, but they have distinct meanings within financial reporting standards. An operating segment is a component of a public entity that engages in business activities, has discrete financial information available, and whose operating results are regularly reviewed by the chief operating decision maker (CODM) for purposes of making decisions about resource allocation and assessing performance. It is the fundamental unit of a business that management evaluates internally.⁷

In contrast, a reportable segment is an operating segment (or a combination of operating segments) that meets specific quantitative thresholds or is deemed qualitatively material enough to warrant separate disclosure to external users in the financial statements. Not all operating segments qualify as reportable segments. Operating segments that do not meet the quantitative thresholds may be combined into an "all other segments" category, provided they share similar economic characteristics and meet other aggregation criteria. The primary distinction is that operating segments are internal management units, while reportable segments are those specific units that a company must present publicly based on accounting rules.

FAQs

What is the purpose of disclosing reportable segments?

The primary purpose of disclosing reportable segments is to provide financial statement users with information about a public entity's different business activities and the economic environments in which it operates. This helps users better understand the entity's performance, assess its future cash flows, and make more informed judgments about the company as a whole.⁶,⁵

How are reportable segments determined?

Reportable segments are determined using a "management approach." This means they are identified based on how the company's chief operating decision maker (CODM) organizes the business and reviews its operating results for making strategic decisions and allocating resources. Once identified, operating segments are tested against quantitative thresholds (10% of revenue, profit/loss, or assets) to determine if they must be separately reported.⁴

Can a company have only one reportable segment?

Yes, a company can have only one reportable segment if its operations are not diversified enough to meet the criteria for multiple reportable segments, or if its operating segments can all be aggregated into a single segment under accounting standards. Even with a single reportable segment, public entities are still required to provide relevant disclosures.³

What kind of information is disclosed for reportable segments?

For each reportable segment, companies typically disclose information about its revenue, profit or loss, and assets. Recent accounting updates also require disclosure of significant segment expenses. Additionally, companies must provide reconciliations of segment totals to the company's consolidated financial statements.²,¹

Why is segment reporting important for investors?

Segment reporting is crucial for investors because it allows them to "see the company through the eyes of management." This disaggregated information helps investors understand the performance drivers of different parts of a business, assess specific risks and opportunities associated with each segment, and make more accurate projections about the company's overall future financial performance. It enhances the utility of financial reporting for investment decisions and capital allocation.