Chapter 2 — Identification of Operating Segments | DART

Chapter 2 — Identification of Operating Segments

2.1 Overview

As stated in ASC 280-10-05-3, the method used to determine what information to report under ASC 280 is called the management approach and is “based on the way that management organizes the segments within the public entity for making operating decisions and assessing performance.” Accordingly, the first step for an entity in applying ASC 280 is the identification of operating segments.

ASC 280-10

50-1 An operating segment is a component of a public entity that has all of the following characteristics:

It engages in business activities from which it may recognize revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same public entity).
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.
Its discrete financial information is available.

Evaluating whether a component has all the characteristics of an operating segment can require judgment, including the consideration of whether:

The component engages in business activities from which it may recognize revenues and incur expenses (see Section 2.2).
The component’s operating results are regularly reviewed by the CODM (see Section 2.3).
Discrete financial information is available for the component (see Section 2.4).

Key Takeaways

Identification of operating segments requires the use of the management approach. In accordance with ASC 280-10-05-3, this approach is “based on the way that management organizes the segments within the public entity for making operating decisions and assessing performance.”
An operating segment possesses the following characteristics: (1) engagement in business activities from which it may recognize revenues and incur expenses, (2) operating results that are regularly reviewed by the CODM to allocate resources and assess performance, and (3) availability of discrete financial information.
Evaluating whether a component has all the characteristics of an operating segment can require judgment.
Various information sources may help an entity identify operating segments, including the entity’s organizational structure (i.e., who are the CODM’s direct reports), the CODM’s periodic reporting package, the level at which budgets are reviewed and approved by the CODM, and an understanding of the incentive compensation structure.

2.2 Engagement in Business Activities

One characteristic of an operating segment is that it engages in business activities from which it may recognize revenues and incur expenses. Because ASC 280-10-50-1 uses the words “may recognize revenues,” the absence of revenues does not preclude a component from being an operating segment.

In addition, ASC 280-10-55-5 clarifies that “[a] division that recognizes revenues and incurs expenses but does not have any assets associated with it for internal reporting purposes could be considered an operating segment, if, under the specific facts and circumstances being considered, it otherwise meets the definition in paragraph 280-10-50-1.”

2.2.1 Research and Development Activities

ASC 280-10

50-3 An operating segment may engage in business activities for which it has yet to recognize revenues, for example, start-up operations may be operating segments before recognizing revenues.

An operating segment can be a component that does not recognize external or internal revenues but for which the CODM is making resource allocation decisions and assessing performance on the basis of expenses. This may occur, for example, when a component is focused on research and development activities and the CODM is regularly reviewing operating results for that component to assess performance and allocate resources (see further discussion in Section 2.3).

Example 2-1

Company P, a diversified pharmaceutical company, has allocated a portion of its combined assets to a component for the research and development of new drugs. Expenses have been incurred; however, the component has yet to recognize revenues from any of the activities. Discrete financial information is available for the component, and the CODM reviews that information to allocate resources and assess performance.

Company P’s intent is to allocate resources to the specific business purpose of research and development. Although revenues potentially will never be recognized from this pursuit, management has made a risk-and-reward determination that the cost of the research will be recovered through future revenues of the component. Company P therefore determines that the component meets the definition of an operating segment.

2.2.2 Corporate Headquarters and Functional Departments

ASC 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 recognize revenues or may recognize 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.

55-3 A corporate division that recognizes revenues (for example, a treasury operation that recognizes interest income) and incurs expenses could be considered an operating segment, if, under the specific facts and circumstances being considered, it meets the definition in paragraph 280-10-50-1. Some believe that corporate divisions could not be considered operating segments because paragraph 280-10-50-4 indicates that 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 that do not recognize revenues or that recognize revenues that are only incidental to the activities of the public entity.

55-4 However, a corporate division that recognizes revenues and that has available discrete financial information and whose operating results are reviewed regularly by the chief operating decision maker should be considered an operating segment. Even if the revenues are considered incidental, this Subtopic 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 public entity.

To qualify as an operating segment, a component must engage in business activities. Therefore, functional departments such as corporate divisions, corporate shared services, or treasury departments typically do not qualify as operating segments if they either (1) do not earn revenue or (2) earn an amount of revenue that is only incidental to the entity’s activities. (Although ASC 280-10-55-4 clarifies that “[e]ven if the revenues are considered incidental, this Subtopic 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 public entity.”) By contrast, if a corporate functional department earns more than an incidental amount of revenue and meets the other criteria in ASC 280-10-50-1, the component may qualify as an operating segment.

Some entities may be organized by functional departments that are accountable for either revenue or costs but not both. Identifying the operating segments of those entities will require careful consideration. Entities that are organized by function rather than by products and services or by geography will need to determine what information the CODM regularly reviews to allocate resources and assess performance. They should also be particularly mindful of the disclosures required by ASC 280, including disclosures related to how the entity is organized (see Section 4.2) and the entity-wide disclosures about products, services, and geography (see Chapter 5).

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).

2.4 Discrete Financial Information

Another characteristic of an operating segment is the availability of discrete financial information. While ASC 280 does not define “discrete financial information,” we believe that it generally involves some measure of a component’s profitability that can be readily distinguished from that of other components of the organization. For example, if the information provided to the CODM contains revenue and gross profit by service line, discrete financial information would be available, and there would generally be enough information to assess performance and make resource allocation decisions by service line.

However, this measure may not reflect GAAP-based earnings or all costs that would be necessary for running the component as a stand-alone business. In many instances, the availability of gross margin for the component will be sufficient to qualify as discrete financial information. This is consistent with comments made at the AICPA Conference on Current SEC and PCAOB Developments in 2015 and 2016 by Division staff members, who noted that the absence of fully allocated costs to a component does not preclude the component from having discrete financial information.

Further, as discussed in ASC 280-10-55-5, allocation of assets is not necessary for a component to be considered an operating segment. Thus, discrete financial information may consist of only limited results of operations information, such as revenues and gross profit margin, without balance sheet information.

Example 2-8

Company D’s CODM receives information about revenue for two products, product A and product B, which are produced by the same operating unit. No expense information is regularly provided or available for either product. The CODM does not have a measure of profit or loss by product, and therefore it is likely that there would not be enough information to assess the performance of the individual products or make resource allocation decisions. In this case, operating segment performance would need to be reported at a level in which discrete financial information is available and provided to the CODM for use in making operational decisions.

2.4.1 Revenue Information Provided to the CODM

For some entities, the information provided to and regularly reviewed by the CODM consists of consolidated operating results and revenue disaggregated in accordance with ASC 606, by product or service line or by geography, with no expenses shown. As discussed above, revenue alone will generally not be sufficient for a CODM to assess performance and allocate resources. However, entities should carefully consider all facts and circumstances, including why the CODM receives disaggregated revenue, how the CODM uses such information, and whether revenue alone is sufficient for the CODM to allocate resources and assess performance.

2.5 Multiple Sets of Data or Components

ASC 280-10

50-6 For many public entities, the three characteristics of operating segments described in paragraph 280-10-50-1 clearly identify a single set of operating segments. However, a public entity may produce reports in which its business activities are presented in a variety of different ways. If the chief operating decision maker uses more than one set of segment information, other factors may identify a single set of components as constituting a public entity’s operating segments, including the nature of the business activities of each component, the existence of managers responsible for them, and information presented to the board of directors.

50-9 The characteristics in paragraphs 280-10-50-1 and 280-10-50-3 may apply to two or more overlapping sets of components for which managers are held responsible. That structure is sometimes referred to as a matrix form of organization. For example, in some public entities, certain managers are responsible for different product and service lines worldwide, while other managers are responsible for specific geographic areas. The chief operating decision maker regularly reviews the operating results of both sets of components, and financial information is available for both. In that situation, the components based on products and services would constitute the operating segments.

Given the framework of the management approach under ASC 280, there may be more than one way to provide discrete financial information to the CODM (e.g., by products and services and also by geography, which would suggest overlapping sets of components). In those instances, an entity may need to use additional judgment to identify operating segments and should consider the following:

The nature of the business activities of each component — For example, if information about products and services and geography is provided, what is the relevance and importance of each type of information to the overall entity? Is primarily one product sold in multiple geographic areas or are multiple products primarily sold in one geographic area?
The existence of segment managers — Which components have segment managers who are accountable to the CODM?
What information is presented to the board of directors — Does the board of directors receive one set of information or more than one set? In this regard, paragraph 70 of the Background Information and Basis for Conclusions of FASB Statement 131 observes that in many enterprises, “only one set of data is provided to the board of directors. That set of data generally is indicative of how management views the enterprise’s activities.”

Example 2-9

Company D has four product lines: E, F, G, and H. Product lines E and F are manufactured in the United States. Product lines G and H are manufactured in China. Company D has vice presidents, who are responsible for each of the product lines, and different sales managers, who are responsible for each geographic area. The CODM only receives discrete financial information by product line. In this case, given the absence of financial information at the geographic level, all four product lines are likely to be identified as operating segments.

2.6 Vertically Integrated Operations

ASC 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.

Some operating segments may derive their revenues only from other segments within the entity. Understanding how the CODM manages the business is the key factor in identifying operating segments. As noted in ASC 280-10-50-2, a component is not required to have external customers or revenues to be classified as an operating segment for financial reporting purposes. In addition, entities with vertically integrated operating segments will need to carefully consider the qualitative criteria in ASC 280-10-50-11 when evaluating whether aggregation of the operating segments is appropriate. See Section 3.2 for further discussion of aggregation.

Example 2-10

Company B is a vertically integrated manufacturer that sells processed food products to external customers. Company B’s operations include a flour mill that sells refined flour to the food processing segment of B. Although the flour mill has no external customers, the financial results of the milling operation are prepared separately, and the CODM regularly reviews them to assess performance and make decisions regarding the allocation of resources. The flour mill would therefore meet the definition of an operating segment.

2.7 Subsidiary Financial Statements

Operating segments should be identified at the reporting-entity level. In some instances, a public entity may have a consolidated subsidiary that meets the definition of a public entity and is therefore within the scope of ASC 280. In such cases, the parent entity would apply the guidance in ASC 280 to identify the operating segments at the consolidated level, and a separate evaluation would be performed for the subsidiary reporting entity.

ASC 280-10

Example 1: Subsidiary of a Public Entity Has Public Debt and Separate Financial Statements Have Reportable Segments

55-27 Assume that an entity is organized as follows.

55-28 This Example discusses the determination of reportable segments (see paragraph 280-10-50-10) by a public entity when one of its subsidiaries is itself a public entity and includes segment information in its separate financial statements.

55-29 Subsidiary C is itself a public entity because it has public debt outstanding. The segment information for the separate financial statements of Subsidiary C discloses three reportable segments (Dept. Y, Dept. Z, and Division 7).

55-30 In this situation it should not be automatically assumed that the reportable segments of Subsidiary C are also reportable segments within the consolidated financial statements of Public Company. Determining the number of operating segments of a public entity depends on the specific facts and circumstances and should be separately evaluated for each public entity that is required to apply this Subtopic.

2.8 Equity Method Investees

ASC 280-10

55-2 An equity method investee could be considered an operating segment, if, under the specific facts and circumstances being considered, it meets the definition in paragraphs 280-10-50-1 and 280-10-50-3. An investee accounted for by the equity method could be considered an operating segment even though the investor has no control over the performance of the investee. Paragraph 280-10-50-1(b) provides that an operating segment is one whose 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. Management may regularly review the operating results and performance of an equity method investee for purposes of evaluating whether to retain the investor-investee relationship. This Subtopic does not require that the chief operating decision maker be responsible for making decisions about resources to be allocated within the segment. That is, this Subtopic does not require that the chief operating decision maker be responsible for making decisions at the investee operating level that affect its operations and performance. Therefore, control over the investee is not a criterion for the investee to be considered an operating segment. For information relating to equity method investees, see Topic 323.

An entity’s operating segments are not limited to its consolidated operations. Equity method investments and joint ventures, for example, may also represent operating segments if they otherwise meet the criteria in ASC 280-10-50-1. ASC 280 does not require that the CODM be responsible for making decisions about resources to be allocated within the segment. Rather, as observed in ASC 280-10-55-2, the CODM may be regularly reviewing the operating results and performance of an equity method investee “for purposes of evaluating whether to retain the investor-investee relationship.” Accordingly, “control over the investee is not a criterion for the investee to be considered an operating segment.”

Example 2-11

Company A manufactures and sells prepackaged food. Company A also holds a 30 percent investment in a venture that operates a flour mill and purchases flour from the venture to use in its operations. It uses the equity method to account for its investment in the venture.

The venture’s financial results are provided quarterly to the venture’s owners. Company A’s CODM reviews the results to make decisions about resources to be allocated to the investment (e.g., whether to participate in any capital calls) and to assess the mill’s performance to determine whether to retain the investment.

In this instance, the joint venture would represent an operating segment given the following factors:

The joint venture engages in business activities (flour milling) from which it recognizes revenues and incurs expenses.
The CODM regularly reviews the joint venture’s operating results to allocate resources and assess performance.
Discrete financial information is available for the venture.

2.9 Comparison to Competitors

The management approach required for determining operating segments under ASC 280 is based on (1) each entity’s facts and circumstances and (2) how the CODM assesses performance and makes resource allocation decisions. While an entity can review segment disclosures from the financial statements of other public entities, including its direct competitors, the disclosures are often not comparable because each CODM may manage differently.

While the FASB requires entities to use the management approach to identify operating segments, it acknowledges that some level of comparability may be important for financial statement users. ASC 280-10-05-5 notes:

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.

See further discussion of entity-wide disclosures of products and services and geographic areas in Chapter 5.

Example 2-12

Company A and Company B both manufacture and distribute windows, siding, and insulation used in the construction of residential and commercial units. Under A’s structure, decisions are made and performance is evaluated on a regional basis (e.g., North, South), whereas B makes decisions and evaluates performance on a product-line basis (e.g., siding, insulation).

Accordingly, A and B would not identify similar operating segments. Rather, A would identify operating segments based on regions, and B would identify operating segments based on product lines.

2.10 Reconsideration of Identified Operating Segments

The identification of operating and reportable segments may be affected by changes in facts and circumstances. For example, a change in the management approach and resulting segment disclosures may result from changes in senior management, significant acquisitions, and significant dispositions as well as changes in the products and services offered by the entity or changes in the entity’s geographic footprint. As discussed in Section 1.7, effective ICFR is necessary to support an entity’s judgment in applying segment guidance and to monitor for changes in the management approach or changes to other facts and circumstances that might result in different segment reporting.

ASC 280 requires a change in reportable segments to be presented in the first period during which the entity is managed on the basis of the new organizational structure. At times, there may be a transition period during which changes to the organizational structure are being implemented and the entity therefore will need to use significant judgment to determine the first period in which it is being managed under the new structure. It may be helpful for the entity to consider the following in making this determination:

When changes to the CODM’s direct reports and their job responsibilities become effective.
When the CODM begins receiving and reviewing discrete financial information under the new reporting structure.
Whether the CODM has been managing the business under the new structure.

If there are changes in identified operating segments, the entity will also be required to perform an updated analysis of the aggregation of operating segments, to identify reportable segments, and to recast the information presented for each reportable segment. In addition, such changes may result in a change to the entity’s reporting units for goodwill impairment testing purposes (see Section 2.9 of Deloitte’s Roadmap Goodwill and Intangible Assets). For a discussion of SEC reporting considerations related to recasting, see Chapter 7.

Example 2-13

Company J manufactures and distributes windows and siding. It is structured so that decisions are made and performance is evaluated by region: north and south. Accordingly, J reports operating segments that are based on the north and south regions. In the first quarter of 20X0, J acquires Company K, which manufactures and distributes doors. Upon completion of the integration of K in the third quarter, J’s CODM allocates financing resources and evaluates the operating segments’ performance by product, rather than region (north and south). For the third quarter of 20X0, J would need to recast its segments to a product basis; therefore, windows, siding, and doors would be the new operating segments. Company J would also need to consider recasting considerations if it undertakes an offering of securities after filing its third quarter Form 10-Q, as noted in Chapter 7.