Chapter 2 — Identification of Operating Segments

2.3 Operating Results Are Regularly Reviewed

Another characteristic of an operating segment is that the CODM regularly reviews the component’s operating results to make decisions about the allocation of resources to the component and to assess its performance. Therefore, in assessing whether an operating segment possesses this characteristic, an entity will need to first identify the CODM. The entity should carefully consider its identification of the CODM to ensure that it appropriately determines its operating segments.

2.3.1 Identification of the CODM

ASC 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.

Changing Lanes

Among other changes, ASU 2023-07 introduces a new requirement that a public entity disclose “[t]he title and position of the individual or the name of the group or committee identified as the chief operating decision maker.” See Section 1.9 for further discussion of the ASU and transition and effective dates.

Paragraph BC37 of the Background Information and Basis for Conclusion of ASU 2023-07 explains, in part:

The Board reasoned that knowledge of the title and position of the CODM within an organization will be useful in providing context for the disclosed segment information. In addition, the Board determined that this information is readily available to be disclosed without additional cost. . . . In addition, many investors stated that disclosing the CODM’s title and position would provide helpful context to the segment information as a whole and may facilitate their ability to ask better questions of management.

2.3.1.1 Overview of CODM

The CODM determines the allocation of resources and assesses the performance of the operating segments. Typically, the CODM is the highest-ranking management individual at the entity who performs such functions, such as the CEO, COO, or a similar role, but sometimes the function is performed by a group. Also, the CODM is not necessarily identified on the basis of rank within the entity. This point was reiterated at the 2015 AICPA Conference on Current SEC and PCAOB Developments when SEC staff observed that an entity’s ultimate decision maker (e.g., the CEO) is not necessarily the CODM; therefore, the entity should identify the CODM by determining which individual (or group of individuals) is responsible for allocating resources and assessing the performance of the entity. In addition, the SEC staff frequently questions how registrants have identified the CODM by asking what the CODM’s role is, which individuals report directly to the CODM, and how often the CODM meets with direct reports.

2.3.1.2 Identify Key Operating Decisions

Determining the key operating decisions that must be made for an entity to recognize revenues and incur expenses will often help the entity identify the CODM. While such decisions will vary depending on the entity and industry, they may include the following:

Entering into significant revenue contracts.
Expanding into new markets or launching new products.
Making significant capital expenditures.
Designing and implementing key marketing strategies.
Hiring and firing key personnel.
Approving operating budgets.

When considering key operating decisions, the entity should distinguish between those decisions made for the entity as a whole, which would typically be made by the CODM, and those decisions related to operating, budgeting, and reporting that are specific to a business unit or component of the entity, which would typically reside with the segment manager. See further discussion of the segment manager in Section 2.3.2.3.1.

2.3.1.3 Chief Executive Officer Versus Chief Operating Officer

Some management structures may include both a CEO and a COO, or a similar role. At the 2014 AICPA Conference on Current SEC and PCAOB Developments, then OCA Deputy Chief Accountant Dan Murdock observed the following:

We have seen entities default to the CEO as the CODM, but I encourage you to take a fresh look at this determination. When identifying the CODM, remember to think about what the key operating decisions are and who is making those decisions for the entity as a whole. Those key operating decisions might not be made at the strategic or ultimate decision level — such as the CEO — but rather by someone who is closer to the day-to-day operations. The guidance does not require the CODM to have ultimate decision making authority, but it is important that the identified individual — or individuals — are evaluating the entity’s operating results to assess performance and to allocate resources. Failing to appropriately identify the CODM would make it highly unlikely you will get to the right [identification of operating segments].

Accordingly, the entity should evaluate what role the COO plays in the organization. For example, a COO may be more administratively focused and responsible for carrying out the CEO’s decisions but not make the key operating decisions or assess performance, which may indicate that the COO is not the CODM or part of a CODM group. However, entities should carefully consider all facts and circumstances, including the stated responsibilities of the COO and his or her interactions with the CEO or CODM group.

Example 2-2

Company A is a manufacturer of sporting equipment used for tennis, badminton, and squash. Company A’s organizational structure includes a CEO and a COO as well as a business president for each of the tennis, badminton, and squash product units. The business presidents are responsible for the operating, budgeting, and reporting aspects of their respective units and have management personnel within their units who report to them. The business presidents each report to the COO and are responsible for making resource allocation recommendations to the COO for their respective units. The COO evaluates the performance of each unit on the basis of a variety of financial reports and is responsible for entity-wide resource allocation decisions.

The COO reports to the CEO. The CEO receives monthly reports on consolidated operations but does not receive information about each of the product units. In addition, the CEO defers all operating decisions to the COO and instead focuses on the strategic direction of the company.

In this instance, the COO would most likely be considered the CODM or a part of a CODM group with the CEO. While the CEO may be seen as the highest level of management, the COO is responsible for the key operating decisions, including entity-wide resource allocation decisions, and for assessing the performance of the three product units.

Example 2-3

Assume the same facts as in the example above except that the three presidents report directly to the CEO. While the COO participates in meetings with the CEO and the presidents, the purpose of such participation is to ensure that the COO understands the business because it is expected that the COO will assume the role of CEO when the CEO retires in the near term. The CEO makes all key operating decisions, including entity-wide resource allocation decisions.

The CEO is most likely the CODM because the CEO, and not the COO, is responsible for the key operating decisions, including entity-wide resource allocation and assessing the performance of the three product units.

2.3.1.4 Management Committees

In some organizations, the CODM may be a management committee composed of, for example, the entity’s CEO or president, its chief financial officer, its executive vice presidents, and others, all of whom participate in decisions made by the committee. However, the existence of a management committee does not necessarily mean that the management committee is the CODM. In identifying the CODM, an entity must consider its management structure as well as any relevant facts and circumstances, particularly when evaluating whether an individual’s override authority is substantive.

Example 2-4

Company B’s management committee consists of a president, a CEO, a chief financial officer, and executive vice presidents. These positions are all held by different individuals, all of whom make operating decisions and assess the performance of B’s operating segments. The management committee is evenly controlled by its members, rather than an individual, and those members make the operating decisions together as a group. Therefore, in this case, the CODM would be the management committee.

2.3.2 Clarifying the Terms “Operating Results” and “Regularly Reviewed”

We believe that the term “operating results” implies at least some measure of profitability. However, the operating results regularly reviewed by the CODM do not need to reflect all costs that would be necessary for the operation of the component as a stand-alone business. Some measure of profitability, such as gross profit or EBITDA, is likely to be sufficient for the CODM to allocate resources and assess performance. See discussion of discrete financial information in Section 2.4.

Further, ASC 280 does not define “regularly reviewed.” In general, we believe that a regular review, for most public entities, would be held at least quarterly. Entities should use judgment in determining which operating results are regularly reviewed by the CODM.

2.3.2.1 Information Sources for Regular Review

Insight into the level at which a CODM reviews operating results to allocate resources and assess performance may be obtained from a variety of sources, including the following:

Information provided to and reviewed by the CODM (the CODM package; see Section 2.3.2.2).
The entity’s organizational structure, including meetings between the CODM and his or her direct reports (see Section 2.3.2.3).
The level at which budgets are prepared and reviewed (see Section 2.3.2.4).
The basis on which compensation is determined (see Section 2.3.2.5).
The information provided to the board of directors (see Section 2.5).

No single factor is determinative in the entity’s analysis. Rather, the entity must consider the totality of the information and carefully consider whether any of it may be inconsistent with the information it used to identify its operating segments.

2.3.2.2 Information Provided to and Reviewed by the CODM (CODM Package)

Typically, the CODM will receive periodic reporting packages that include operating results at a disaggregated level. Such reports may indicate the levels at which the CODM is monitoring the business to allocate resources and assess performance.

Historically, when evaluating an entity’s operating segments, the SEC staff has placed a great deal of emphasis on the information regularly provided to and reviewed by the CODM. The SEC staff frequently requests copies of the CODM package, as well as the information provided to the entity’s board of directors, and attempts to reconcile that information to the entity’s reported operating segments.

In its 2012 postimplementation review report on FASB Statement 131, the FAF observed that:

Advances in information technology also make the guidance for determining operating segments more difficult to apply and audit. Technology allows more detailed financial information to be available to the CODM. The ability of the CODM to access more detail makes less clear what the CODM “receives” and “regularly reviews.” As a result, it might be more difficult to determine operating segments and less clear how to aggregate them.

Partly in response to the FAF’s observation, the SEC staff has noted that its historical views regarding an entity’s CODM package are evolving and that in the past it may have overemphasized the importance of the CODM package. The SEC staff indicated that rather than viewing the CODM package as the determinative factor in identifying operating segments, it would consider the CODM package as only one of many factors in the determination. Other factors include (1) what financial information is regularly reviewed by the board of directors, (2) the registrant’s organizational chart and overall management structure, (3) the basis on which budgets and forecasts are prepared and reviewed, and (4) the basis on which executive compensation is determined.

Similarly, the SEC staff noted that it would not view the CODM package as a safe harbor for entities. That is, the SEC staff might conclude that other, potentially conflicting information would overcome the absence of operating results in the CODM package for a potential operating segment. Entities should expect the SEC staff to:

Question whether there are disaggregated operating results not included in the CODM package that are nonetheless regularly reviewed by the CODM.
Continue to review other publicly available information for consistency with the entity’s segment disclosures, such as the information in the forepart of the Form 10-K (i.e., the business and MD&A sections), the entity’s Web site, analysts’ reports, and press releases.

While the CODM package is not the determinative factor in the identification of operating segments, it is still a significant information source. Therefore, the staff will continue to ask what information is regularly provided to the CODM and, in some instances, may request copies of the CODM package.

2.3.2.2.1 Other Financial Reporting

In certain instances, an entity may prepare stand-alone financial statements for one or more subsidiaries (e.g., when such financial statements are necessary to meet a statutory reporting requirement). The existence of such stand-alone financial statements is not in itself determinative that the portion of the entity being reported on is representative of an operating segment. Rather, those financial statements should be evaluated to determine whether they are regularly reviewed by the CODM to make decisions about resources to be allocated and to assess the subsidiary’s performance.

2.3.2.3 Organizational Structure

An entity’s management structure will often offer insight into how the CODM is reviewing operating results to allocate resources and assess performance. As discussed in Section 1.2, the framework for segment reporting is the management approach, which is based on an entity’s internal organization. Determining the following may help an entity understand how management is structured:

Who the CODM’s direct reports are.
What decisions the CODM’s direct reports make and what their roles and responsibilities are.
How frequently the CODM meets with his or her direct reports, what financial information is prepared for review in those meetings, and what is typically discussed in those meetings.
Whether there are other individuals, groups, or committees within the entity with whom the CODM regularly meets to discuss operating results.

2.3.2.3.1 Segment Manager

ASC 280-10

50-7 Generally, an operating segment has a segment manager who is directly accountable to and maintains regular contact with the chief operating decision maker to discuss operating activities, financial results, forecasts, or plans for the segment. The term segment manager identifies a function, not necessarily a manager with a specific title.

50-8 The chief operating decision maker also may be the segment manager for certain operating segments. A single manager may be the segment manager for more than one operating segment. If the characteristics in paragraphs 280-10-50-1 and 280-10-50-3 apply to more than one set of components of a public entity but there is only one set for which segment managers are held responsible, that set of components constitutes the operating segments.

An entity’s understanding of the organizational structure and of who the CODM’s direct reports are, including how those direct reports interact with the CODM, can help the entity gain insight into how the CODM is reviewing operating results to allocate resources and assess performance.

Example 2-5

Company A is a multinational retailer of women’s clothing. It operates four brands: Workout Wear, Business Wear, Casual Wear, and Evening Wear. The company’s CEO is the CODM.

In identifying its operating segments, A notes the following:

Each brand has a division president that reports directly to the CEO.
The quarterly CODM package includes a consolidated P&L statement as well as revenue and EBITDA for each brand.
The CODM and division presidents meet quarterly to review the divisional P&L information, including actual results and comparisons to budget.
Annual budgets are prepared by each division president through EBITDA. The final budgets for each division are approved by the CEO.
Total annual compensation for the division presidents is based, in part, on brand EBITDA.

Given these facts, A appears to have four operating segments: Workout Wear, Business Wear, Casual Wear, and Evening Wear, since (1) each segment engages in business activities that recognize revenues and incur expenses, (2) the CODM is regularly reviewing the operating results of each brand to allocate resources and assess performance, and (3) discrete financial information is available for each brand. Each of the four division presidents also appears to be a segment manager. Each of the division presidents is directly accountable to and maintains regular contact with the CODM to discuss the operating activities, financial results, and forecasts for the division.

Example 2-6

Assume that Company A in the example above undergoes a reorganization in which the four division presidents are consolidated into a single president of operations who reports to the CODM. The CODM continues to receive revenue and EBITDA by brand each quarter and discusses operating results for each brand with the president of operations. The CODM prepares and approves budgets for each brand, and the president of operations is compensated on the basis of consolidated financial results.

Given these facts, it appears that A still has four operating segments upon the reorganization: Workout Wear, Business Wear, Casual Wear, and Evening Wear since the CODM continues to review operating results of each brand to allocate resources and assess performance. The president of operations is likely to be considered the segment manager for each brand.

2.3.2.4 Budgeting Process

An entity’s budgeting process can be instructive on how resource allocation decisions are made (including the level at which resources are allocated) and how performance is assessed. For example, the process may indicate:

The level at which budgets are reviewed and approved by the CODM (i.e., the consolidated budget level or some disaggregated level).
The level at which the CODM regularly reviews performance against those budgets.

Accordingly, the CODM’s review of budgets (and performance against those budgets) on a disaggregated basis may indicate the level at which the CODM is regularly reviewing operating results to allocate resources and assess performance.

Example 2-7

Company C’s CODM reviews revenue information for two components, component A and component B. Certain consolidated expenses reviewed by the CODM are not allocated to the components. However, the CODM meets with the segment managers of A and B to discuss each component’s operations, and the CODM receives incentive compensation derived from the operating results and key performance measures for each component. Further, budgets are approved and reviewed at the component level. In the determination of what constitutes the operating segments, these factors may indicate that the CODM is regularly reviewing operating results to allocate resources and assess performance at the component level.

2.3.2.5 Compensation Structure

An entity’s compensation structure, including how the CODM’s direct reports are compensated, may also provide insight into how the CODM is allocating resources and assessing performance. For instance, the fact that a portion of compensation for the CODM’s direct reports is tied to the performance of the components or business units they oversee may indicate that the CODM is allocating resources and assessing performance at that level. We believe that this conclusion is consistent with the guidance in ASC 280-10-50-7, which notes that operating segments will generally have “a segment manager who is directly accountable to and maintains regular contact with the [CODM].” Therefore, the existence of managers whose compensation is associated with their accountability to the CODM for the performance of components or business units may help an entity identify its operating segments. However, as discussed above, compensation structure is not determinative in the analysis (i.e., a compensation structure based on consolidated results would not necessarily indicate that the entity has a single operating segment).

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.