3.2 Step 1: Evaluate Operating Segments for Aggregation | DART

3.2.1 Criteria for Aggregation

ASC 280-10

50-11 Operating segments often exhibit similar long-term financial performance if they have similar economic characteristics. For example, similar long-term average gross margins for two operating segments would be expected if their economic characteristics were similar. Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the objective and basic principles of this Subtopic, if the segments have similar economic characteristics, and if the segments are similar in all of the following areas (see paragraphs 280-10-55-7A through 55-7C and Example 2, Cases A and B [paragraphs 280-10-55-33 through 55-36]):

The nature of the products and services
The nature of the production processes
The type or class of customer for their products and services
The methods used to distribute their products or provide their services
If applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.

50-18A An entity need not aggregate similar segments, and it may present segments that fall below the quantitative thresholds.

Under ASC 280-10-50-11, two or more operating segments may be aggregated if the following three criteria are met:

Criterion 1 — Aggregation is consistent with the objectives and basic principles of ASC 280 (see Section 3.2.2).
Criterion 2 — The segments have similar economic characteristics (see Section 3.2.3).
Criterion 3 — The segments are similar with respect to the five qualitative characteristics specified in ASC 280-10-50-11(a)–(e) (see Section 3.2.4).

Further, an entity is not required to aggregate similar operating segments. Accordingly, step 1 is optional, and an entity may proceed directly to the quantitative tests in step 2.

3.2.1.1 Evaluation of “Similar”

ASC 280-10

Aggregation Criteria

55-7A Paragraph 280-10-50-11 states that operating segments are considered to be similar if they can be expected to have essentially the same future prospects. Therefore, the similarity of the economic characteristics should be evaluated based on future prospects and not necessarily on the current indicators only. In other words, if the segments do not currently have similar gross margins and sales trends but the economic characteristics and the other five criteria are met and the segments are expected to again have similar long-term average gross margins and sales trends, the two segments may be aggregated.

55-7B Likewise, if segments generally do not have similar economic characteristics, but in the current year have similar gross margins or sales trends and it is not expected that the similar gross margins or sales trends will continue in the future, it should not be presumed that the segments should be aggregated for the current-year segment disclosures just because current economic measures are similar.

55-7C Aggregation of segments should be consistent with the objective and basic principles of this Subtopic — to provide information about the different types of business activities in which a public entity engages and the different economic environments in which it operates in order to help users of financial statements better understand the public entity’s performance, better assess its prospects for future net cash flows, and make more informed judgments about the public entity as a whole. This Subtopic mentions that segments having similar economic characteristics would be expected to have similar long-term average gross margins. That measure is used, only as an example, because gross margin is a measure of profitability that is less likely to be affected by allocations. Evaluating similar economic characteristics is a matter of judgment that depends on specific facts and circumstances.

ASC 280 does not define the term “similar” or provide extensive guidance on the aggregation criteria, and the assessment of whether two or more operating segments are similar depends on facts and circumstances. Therefore, the determination that two or more operating segments should be aggregated is subject to judgment and is a high hurdle to overcome. As a result, we believe that the SEC staff may ask a registrant to provide an analysis on how it determined that its aggregation of operating segments complies with both the quantitative and qualitative requirements of ASC 280. At the 2015 AICPA Conference on Current SEC and PCAOB Developments, staff from the SEC’s OCA noted:

In determining whether two operating segments are “similar” with respect to the economic characteristics and each of the qualitative criteria, the guidance notes the evaluation should be made relative to the range of the entity’s business activities and the economic environments in which it operates. For example, some entities operate within a single industry segment but may have multiple product lines by which it has defined its operating segments. Under the guidance, the entity would need to consider the range of those product lines and the characteristics of each that drive economic performance when evaluating aggregation. In doing so, it may be helpful to consider whether a reasonable investor would consider the two operating segments to be similar. Often, [publicly] available industry reports and other analysis by users will indicate the key characteristics by which a reasonable investor may analyze the entity. [Footnote omitted]

Paragraph 74 of the Background Information and Basis for Conclusions of FASB Statement 131 notes, in part, that “[t]he Board recognizes that determining when two segments are sufficiently similar to justify aggregating them is difficult and subjective.”

When assessing whether operating segments may be aggregated, registrants that have complex business models and reporting structures may find it particularly difficult to determine the basis for economic similarity. Accordingly, we believe that the SEC staff may ask registrants that have aggregated segments how they satisfied the quantitative requirements of ASC 280 and may request historical and projected financial information by operating segment. Further, the staff continues to challenge a registrant’s conclusion that operating segments may be aggregated when the entity provides the CODM with profit measures for a level below the reportable segment. The SEC staff has also emphasized that registrants should focus on the qualitative factors in ASC 280 (e.g., similarity of products and customers) when assessing whether operating segments are similar for aggregation purposes.

3.2.1.2 Application of Reasonable Judgment

When applying the aggregation criteria in ASC 280-10-50-11, an entity must use reasonable judgment. At the 2015 AICPA Conference on Current SEC and PCAOB Developments, staff from the SEC’s OCA observed:

Reasonable judgment with a thorough understanding of an entity’s specific facts and circumstances is required in applying these criteria. This judgment is informed by the starting point in the analysis, which is that management has first determined the information it finds useful (and uses) in managing the business is at a disaggregated operating segment level. [Footnote omitted]

Accordingly, when evaluating whether it has met the aggregation criteria in ASC 280-10-50-11, an entity may find it helpful to first consider why it has identified multiple operating segments for resource allocation and performance assessment purposes. While the CODM’s review and the segment reporting objectives are not identical, both focus on performance and decision-making about the future. Understanding how management runs the business and the usefulness of disaggregated information for the CODM will often help the entity decide whether two or more operating segments are similar.

In its reviews, the SEC staff has routinely requested clarification about whether an entity’s operating segments have been aggregated and, if so, the entity’s analysis resulting in a conclusion that aggregation was appropriate. We believe that an entity should maintain contemporaneous documentation of its aggregation analysis, including the evaluation of ICFR related to its key judgments. This analysis should address each of the aggregation criteria, including whether aggregation is consistent with the objectives and basic principles of ASC 280 and how the entity determined that providing more detailed segment disclosure would detract from these objectives.

3.2.1.3 All Aggregation Criteria Must Be Met

All three of the criteria in ASC 280-10-50-11 must be met for an entity to aggregate two or more operating segments. Paragraph 74 of the Background Information and Basis for Conclusions of FASB Statement 131 states, in part:

[T]he Board rejected recommendations that the criteria be indicators rather than tests and that the guidance require only the expectation of similar long-term performance of segments to justify aggregation because those changes might result in a level of aggregation that would cause a loss of potentially valuable information. For the same reason, the Board also rejected suggestions that segments need be similar in only a majority of the characteristics in [ASC 280-10-50-11] to justify aggregation.

This requirement was reiterated at the 2014 AICPA Conference on Current SEC and PCAOB Developments, when then OCA Deputy Chief Accountant Dan Murdock noted the following:

The underlying principle [to aggregation of operating segments] is that separate reporting of segment information will not add significantly to an investor’s understanding of an entity if its operating segments have characteristics that are so similar they can be expected to have essentially the same future prospects. That said, the aggregation criteria are intended to be a high hurdle, and you need to meet all of the criteria in order to aggregate operating segments. The FASB specifically rejected recommendations that the criteria be indicators rather than tests and that an expectation of similar long-term performance alone would be sufficient to justify aggregation, noting that such relaxed criteria might result in a level of aggregation that would cause a loss of potentially valuable information. [Footnotes omitted and emphasis added]

3.2.1.4 Aggregation Into a Single Reportable Segment

In some situations, an entity may evaluate the aggregation criteria and conclude that all of its operating segments may be aggregated into a single reportable segment. While such a determination may not necessarily be incorrect, it may be subject to heightened regulatory scrutiny given that ASC 280 was intended to elicit useful information about the different types of business activities in which an entity engages. An entity that determines that aggregation into a single reportable segment is reasonable is likely to be challenged by the SEC staff to explain why, if the CODM uses disaggregated information to allocate resources and assess performance, that information would not be meaningful to users of the financial statements.

Changing Lanes

After the adoption of ASU 2023-07, a public entity that has a single reportable segment must provide all the disclosures required by both the ASU and the existing segment guidance in ASC 280. In other words, the measure(s) of segment profit or loss disclosed in the financial statements would need to be reconciled to consolidated income before income taxes and discontinued operations. See Section 4.2.1 for reporting considerations for entities with a single reportable segment.

SEC Considerations

During the OCA session on current accounting issues at the 2023 AICPA & CIMA Conference on Current SEC and PCAOB Developments, SEC Associate Chief Accountant Carlton Tartar discussed considerations related to determining the segment measure of profit or loss for entities with a single reportable segment under ASU 2023-07. Mr. Tartar indicated that when an entity has a single reportable segment and is managed on a consolidated basis, the SEC would expect the entity to conclude under the new guidance in ASC 280-10-55-15D, added by ASU 2023-07, that the measure of segment profit or loss that is most consistent with U.S. GAAP is consolidated net income.

We encourage entities to consider discussing with their auditors, SEC counsel, or the SEC staff how the staff’s view should be applied in cases in which an entity has a single reportable segment and management concludes that (1) it does not manage the entity on a consolidated basis and (2) a measure of segment profit or loss other than consolidated net income prepared in accordance with U.S. GAAP may be appropriate.

3.2.2 Aggregation Must Be Consistent With the Objectives and Principles of ASC 280 (Criterion 1)

ASC 280-10-50-11 requires the aggregation of operating segments to be consistent with the objectives and basic principles of segment reporting outlined in ASC 280-10-10-1, which are intended to help financial statement users:

Better understand an entity’s different types of business activities, the different economic environments in which it operates, its performance, and its prospects for future net cash flows.
Make more informed judgments about the entity as a whole.

Example 3-1

Company A owns and operates the Best Burger chain of restaurants, with locations across the United States and Europe. Company A has identified two operating segments: the United States and Europe. In evaluating whether aggregation is consistent with the objectives and principles of ASC 280, A notes that, while restaurants in both the United States and Europe offer the same menu, the economic environment in Europe has put significant pressure on sales, and A is not expecting its sales in Europe to grow as much as those in the United States. As a result of the different economic environments of the United States and Europe segments and the different prospects for future cash flows of the Europe segment, aggregation of the United States and Europe operating segments may not be consistent with the objectives and principles of ASC 280.

Example 3-2

Consider Example 2-10, in which 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 segments 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. Therefore, the flour mill operation would meet the definition of an operating segment.

Assume that B has identified two operating segments: flour mill and processed food products. The business activity of the flour mill (i.e., to process wheat into flour) may be considered different from that of the processed food products segment (i.e., to process ingredients into prepared foods). Therefore, aggregation of the flour mill and processed food products segments may not be consistent with the objectives and principles of ASC 280.

3.2.3 Similar Economic Characteristics (Criterion 2)

ASC 280-10-50-11 states, in part, that operating segments must have similar economic characteristics to be aggregated:

Operating segments often exhibit similar long-term financial performance if they have similar economic characteristics. For example, similar long-term average gross margins for two operating segments would be expected if their economic characteristics were similar.

Unlike the quantitative thresholds outlined in ASC 280-10-50-12, there are no defined thresholds or “bright lines” in the evaluation of whether two or more operating segments possess similar economic characteristics. That is, ASC 280 does not define the term “similar” or provide guidance on the time horizon of historical and expected future periods to be evaluated. Rather, an entity must carefully consider the specific facts and circumstances when evaluating whether two or more operating segments have similar economic characteristics.

The SEC considers aggregation a high hurdle to overcome and may focus on differences in performance metrics when assessing whether operating segments meet the criteria to be aggregated. We believe that the SEC staff presumes that investors would prefer to receive disaggregated information about an entity’s operating segments.

3.2.3.1 What Measures to Consider

While ASC 280-10-50-11 specifies that segments with similar economic characteristics would be expected to have similar long-term average gross margins, it does not describe other factors that an entity can use to evaluate economic characteristics. ASC 280-10-55-7C states, in part:

This Subtopic mentions that segments having similar economic characteristics would be expected to have similar long-term average gross margins. That measure is used, only as an example, because gross margin is a measure of profitability that is less likely to be affected by allocations.

As noted above, the measures that will be relevant for an entity will depend on its facts and circumstances. The entity may also decide to examine additional performance metrics (in addition to gross margin as noted above), such as sales growth, operating margins, operating cash flows, return on assets, EBITDA, inventory turnover, and other standard industry measures.

Further, an entity should consider competitive, operating, and financial risks related to each business or industry type in determining whether two operating segments have similar economic characteristics. If operating segments are in different geographic areas, the entity may need to evaluate factors such as economic and political conditions, currency risks, and foreign exchange control regulations.

3.2.3.2 Quantitative Considerations

When evaluating the similarity of measures of profitability used by the CODM, an entity will need to use reasonable judgment. Generally, we believe that as the differences in the ranges of measures of profitability increase among the operating segments evaluated for aggregation, so too will the amount of evidence needed for the entity to assert that the operating segments have similar economic characteristics. In assessing the range of measures, the entity should consider:

The particular measures of profitability used by the CODM (e.g., an acceptable range related to gross profit may be lower than an acceptable range related to pretax income that may incorporate nonrecurring or other one-time charges).
The expected variability of such measures.
The consistency of the measures of profitability throughout the entity’s industry (e.g., an acceptable range related to a measure associated with a relatively stable amount of profitability may be lower than that associated with less stable amounts).

3.2.3.3 Time Horizon for Analysis

As ASC 280-10-50-11 notes, “Operating segments often exhibit similar long-term financial performance if they have similar economic characteristics.” While the guidance does not define “long-term” or the period over which an entity should evaluate economic performance, it does require an entity to consider past, present, and future financial performance when evaluating whether two or more operating segments have similar economic characteristics. Accordingly, an entity cannot solely look to projected economic performance and ignore current or historical differences. The presence of operating segments with historically dissimilar financial performance may indicate that the segments do not have similar economic characteristics, even if management projects that financial performance will converge over time. Therefore, an entity should carefully consider the underlying factors that historically resulted in the segments’ dissimilar financial performance.

We believe that when an entity considers economic performance, its aggregation analysis should take into account historical, current, and projected performance. The SEC staff typically requests an analysis of revenues and profit or loss (e.g., gross profit or operating profit) by operating segment that covers the past three to five years as well as the current interim period and demonstrates that aggregated operating segments exhibit similar economic characteristics (e.g., similar sales trends, similar gross margin percentages). We believe that the SEC staff may also ask a public entity to provide projected profitability for several years into the future; therefore, an entity may want to consider its forecasts and long-range plans when evaluating whether economic characteristics are similar.

Sometimes a newly acquired entity may qualify as an operating segment and may meet all the criteria needed to be aggregated with an entity’s existing operating segment, except that the segments’ measures of profitability used by the CODM are not similar at the time of the acquisition. If the entity forecasts that the measures of profitability will converge in the near term as a result of the realization of synergies and other cost-cutting initiatives, it would not be precluded from aggregating the new operating segment with its existing operating segment provided that all of the other aggregation criteria are met. However, the assumptions and forecasts must be determined to be reasonable and achievable in the short term. The entity should continue to monitor its operating segments to assess whether aggregation continues to be appropriate, especially if some or all of the synergies or other cost-cutting measures are not realized. Alternatively, the entity may elect not to aggregate the operating segments at the time of the acquisition and may instead choose to monitor the performance of the operating segments and elect to aggregate them in the future if all the aggregation criteria are met.

3.2.3.4 Adjustments to Measures of Profitability

Adjustments that are made to the measure of profitability evaluated by the CODM in the determination of whether the operating segments have similar economic characteristics can result in questions about whether the operating segments subject to the adjustments have similar economic characteristics. While adjustments for certain one-time, nonrecurring charges may be appropriate, an entity should be able to demonstrate that the adjustments would not obscure underlying dissimilarities in economic characteristics.

3.2.4 Similar Qualitative Characteristics (Criterion 3)

To be eligible for aggregation under ASC 280-10-50-11, operating segments must be similar with respect to the following five qualitative characteristics:

“The nature of the products and services” (see Section 3.2.4.1).
“The nature of the production processes” (see Section 3.2.4.2).
“The type or class of customer for their products and services” (see Section 3.2.4.3).
“The methods used to distribute their products or provide their services” (see Section 3.2.4.4).
“If applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities” (see Section 3.2.4.5).

3.2.4.1 Nature of Products and Services

ASC 280 does not indicate how to determine whether products and services have a similar nature, and there are differences between the concepts of (1) similar products and services and (2) similar economic characteristics. While products and services whose nature is similar tend to have similar economic characteristics, the reverse is not necessarily true.

As described in paragraph 68 of the Background Information and Basis for Conclusions of FASB Statement 131, the assessment of whether products or services are similar may depend, in part, on the nature and breadth of a company’s product lines and overall operations. Paragraph 68 states, in part:

An enterprise with a relatively narrow product line may not consider two products to be similar, while an enterprise with a broad product line may consider those same two products to be similar. For example, a highly diversified enterprise may consider all consumer products to be similar if it has other businesses such as financial services and road construction. However, an enterprise that sells only consumer products might consider razor blades to be different from toasters.

Example 3-3

Company A is a large manufacturer of cleaning solvents and solutions for use by residential homeowners and commercial business entities (e.g., restaurants and hotels). Company A’s environmentally friendly cleaning solutions are geared toward residential homeowners, and its industrial-strength cleaners are geared toward commercial businesses. Company A has identified two operating segments: residential and commercial.

Because the production processes and key ingredients for each segment’s products are similar, they have similar gross margins. However, A is expecting higher growth within the residential segment because customers are increasingly looking for environmentally friendly solutions.

Accordingly, A may conclude that, relative to the range of its business activities and the economic environments in which it operates, the nature of its residential operating segment’s products (environmentally friendly cleaning solutions) is not sufficiently similar to that of its commercial operating segment’s products (industrial-strength cleaners) and that therefore the two operating segments are not similar under ASC 280-10-50-11. However, A would need to carefully consider all relevant facts and circumstances.

Example 3-4

Assume the same facts as in the example above, except that Company A has diversified beyond cleaning solvents to also own and operate the following:

Web solutions — A Web-based application for cleaning services that matches homeowners with housecleaners. The application is free to use for the homeowner. Company A receives a listing fee from the housecleaner and sells advertising in the application to large retailers and manufacturers.
Recycling solutions — Recycling services for large electronics and appliances such as vacuum cleaners, washing machines, and dishwashers. In exchange for a fee, recycling solutions will pick up the electronics or appliances and recycle the materials.

Company A has identified four operating segments: residential cleaning solvents, commercial cleaning solvents, Web solutions, and recycling solutions.

Company A may determine that the products and services for the residential and commercial operating segments have a similar nature given the range of A’s products and services, which include the Web-based application and recycling services. However, as in the previous example, all facts and circumstances should be considered. Company A would need to ensure that all of the aggregation criteria in ASC 280-10-50-11 have been met, including the requirement for operating segments to have similar economic characteristics and for aggregation to be consistent with the objectives and principles of ASC 280, before it could conclude that the residential and commercial operating segments may be aggregated.

3.2.4.2 Nature of Production Processes

Indicators of similarities in the nature of production processes may include the sharing of common or interchangeable production facilities, equipment, labor forces, or service groups as well as similar levels of labor or capital. If operating segments source all or most of the products from external suppliers, entities should evaluate the similarities in the similarity of the production processes of the external suppliers of the outsourced products.

3.2.4.3 Type or Class of Customer for the Entity’s Products and Services

Management should evaluate the type or class of customers on the basis of the same criteria it uses to evaluate the customer for operational purposes. This evaluation may consider marketing and promotional efforts, the existence of common or interchangeable sales forces, average spending per customer, and customer demographics, such as average age and income. Generally, retail and wholesale operations would not be considered similar and therefore would not satisfy this criterion.

An entity should also carefully consider the mix of customers in an operating segment (e.g., a combination of retail and wholesale operations or company-owned and franchised stores). Even if two or more operating segments have similar customers, if one of the segments has an incremental customer base, the two segments will most likely not have a similar class of customer.

Example 3-5

Company A is a retailer of women’s fashion and has identified two operating segments: luxury handbags and budget handbags. The luxury handbag operating segment consists solely of company-owned retail locations across the United States. Company A’s budget handbags are sold at its company-owned retail locations as well as wholesale to large department stores.

Since the budget handbag operating segment contains a customer base (i.e., wholesale to the department stores) that the luxury handbag operating segment does not, A would most likely conclude that the nature or class of customer for the luxury and budget segments is not similar. Company A would also need to consider other factors, such as the type or class of customer for its luxury handbags versus that for its budget handbags.

3.2.4.4 Methods Used to Distribute the Entity’s Products or to Provide Services

An entity should evaluate the methods of distribution on the basis of the nature of the distribution channels used (e.g., retail outlets, mail order, Web site).

3.2.4.5 Nature of Regulatory Environment

An entity should also evaluate the nature of the regulatory environments in which it operates. For example, there may be differences between the operating segments of a diversified entity when those segments are not all subject to the same or similar regulatory environment (e.g., banking, insurance, or public utilities).

3.2.5 Consistent Description of the Entity

As stated in ASC 280-10-05-4, the management approach “facilitates consistent descriptions of a public entity in its annual report and various other published information.” The information presented in the segment footnote of the financial statements should be consistent with (1) the information presented throughout a public entity’s SEC filings, including the annual report to shareholders, Form 10-K (including the description of business and MD&A), and Form 10-Q; and (2) its other external information (including company Web sites, financial analysts’ reports, earning calls, investor decks, interviews and other public statements made by management, and other public information). When evaluating whether two or more operating segments may be aggregated, an entity should consider whether such aggregation would be consistent with the entity’s presentation of its operations in other sources of public information.

Example 3-6

Company A is a large retailer that operates stores that sell two types of products: (1) clothing for men and women and (2) home products (e.g., linens, decorative items, and some clothing). In A’s MD&A in Form 10-K, its discussion of changes in operations of the home product stores was different from that of the clothing stores regarding customer demographics, products offered, and sales and profit margin trends. The president’s letter also stressed important distinctions between the two segments.

Company A is therefore likely to conclude that the home product segment should not be aggregated with the clothing segment because all of the aggregation criteria in ASC 280-10-50-11 are not satisfied. Specifically, on the basis of the discussion in MD&A and in the president’s letter, it does not appear that the two operating segments have similar economic characteristics and similar products and types or classes of customer.

3.2.6 Reassessment of Aggregation Criteria in Interim Periods

While an entity generally will not need to reassess the aggregation criteria in each interim period, if a change in facts and circumstances suggests that aggregation of operating segments in the current or future periods is no longer appropriate, management should reassess the aggregation criteria in the period in which the change occurred. If different reportable segments are identified as a result of this reassessment, the disclosures required under ASC 280-10-50-34 and 50-35 should be provided. See further discussion in Section 4.9.

3.2.7 Disclosure of Aggregated Operating Segments

ASC 280-10-50-21(a) requires disclosure if operating segments have been aggregated. When evaluating an entity’s reported segments, the SEC staff has routinely requested clarification about whether operating segments have been aggregated and, if so, the analysis in which the entity concluded that aggregation was appropriate. See further discussion of ASC 280’s disclosure requirements in Chapter 4.

3.2.8 Economic Performance Measures Differ in a Single Year

ASC 280-10

Case B: Economic Performance Measures Differ From the Prior Year

55-35 Assume that Segments A and B meet all of the five criteria for aggregation and have similar economic characteristics; however, this year certain economic performance measures differ. For example, gross margins differ slightly and sales of the segments, which typically move in tandem, trended slightly differently the current year. Those differences were due to inventory problems caused by the entity’s suppliers, and it is expected that the margins and sales trends of Segments A and B will again be similar next year.

55-36 Even though economic performance measures differ, under this fact pattern Segment A may be aggregated with Segment B for current-year segment disclosures. Paragraph 280-10-50-11 states that operating segments are considered to be similar if they can be expected to have essentially the same future prospects. Paragraph 280-10-55-7A explains that the similarity of the economic characteristics should be evaluated based on future prospects and not necessarily on the current indicators only.