2.20 Segment Reporting

ASC 280 prescribes the “management approach” for the identification of segments in a public entity’s financial statements. The objective of the management approach is to allow financial statement users to (1) see the entity’s performance through the eyes of management, (2) assess the entity’s prospects for future cash flows, and (3) make more informed judgments about the entity’s performance. Accordingly, the SEC staff will consider a number of factors when evaluating a registrant’s identification of operating segments, including (1) what financial information is regularly reviewed by the CODM (i.e., the “CODM package”) and board of directors, (2) a 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. A registrant should also expect that the staff will review other publicly available information for consistency with the registrant’s segment disclosures; such information may include the forepart of Form 10-K (i.e., the business section and MD&A), the registrant’s Web site, analysts’ reports, press releases, and investor presentations.

Registrants should also be aware that incorrect identification of operating segments can affect goodwill impairment testing. Goodwill is tested at the reporting-unit level in accordance with ASC 350-20, and reporting units are identified as either operating segments or one level below. If a registrant has not correctly identified its operating segments, it could incorrectly identify its reporting units and, as a result, improperly test goodwill for impairment. See Section 2.11.1.2 for additional information.

Under ASC 280-10-50-11, entities may aggregate operating segments into a single operating segment if (1) aggregation is consistent with the objectives and principles of ASC 280, (2) the operating segments exhibit similar economic characteristics (e.g., similar historical and expected future performance, such as through similar long-term average gross margins), and (3) the operating segments are similar with respect to all of the following qualitative characteristics:

ASC 280 does not define the term “similar” or provide extensive guidance on the aggregation criteria. Therefore, determination of whether two or more operating segments are similar depends on facts and circumstances and is subject to judgment. As a result, 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.

In the assessment of whether operating segments may be aggregated, determining the basis for economic similarity is particularly difficult for registrants that have complex business models and reporting structures. Accordingly, 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 should be aggregated when the registrant reports 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., similar products and customers) when assessing whether operating segments are similar for aggregation purposes.

Registrants should continually monitor any changes in facts and circumstances that may affect the identification or aggregation of operating segments. Changes that may prompt the SEC staff to seek additional information about registrants’ reportable segments include changes in internal reporting after an acquisition or disposition and changes in the CODM.

If a registrant changes the structure of its business in a manner that causes the composition of its reportable segments to change, it is required, in accordance with ASC 280-10-50-34 and 50-35, to recast segment information from prior periods for consistency with current reportable segments unless doing so would be impracticable. If a registrant changes the structure of its business after year-end or quarter-end, the new segment structure should not be presented in financial statements until operating results managed on the basis of that structure are reported (typically in a periodic filing such as a Form 10-K or 10-Q). Paragraph 13310.1 of the FRM indicates that “[i]f annual financial statements are required in a registration or proxy statement that includes subsequent periods managed on the basis of the new organization structure, the annual audited financial statements should include a revised segment footnote that reflects the new reportable segments.” A registrant can include the revised financial statements (1) in the registration or proxy statement or (2) in a Form 8-K, which can be incorporated by reference.

In addition, a change in identified operating segments may also result in a change to a registrant’s reporting units for goodwill impairment testing purposes. See Section 2.11.1.2 for additional information.

ASC 280 also requires disclosure of revenue by product or service on an entity-wide basis. Therefore, registrants should remember to identify the “[t]ypes of products and services from which each reportable segment derives its revenues” and to report the total “revenues from external customers for each product and service or each group of similar products and services” in accordance with ASC 280-10-50-21 and ASC 280-10-50-40, respectively. The SEC staff has objected to overly broad views of what constitute “similar” products and services.

The staff has also frequently asked registrants to include disclosures about geographic information in accordance with ASC 280-10-50-41 unless it is impracticable to do so.

ASC 280 also requires certain reconciliations to consolidated amounts. Reconciliations for income statement amounts should be performed for each period presented. However, as noted in ASC 280-10-50-20, “reconciliations of balance sheet amounts for reportable segments to consolidated balance sheet amounts are required only for each year for which a balance sheet is presented.” The SEC staff has commented on the omission of some or all of the reconciliations required by ASC 280-10-50-30 and 50-31, as well as on reconciliations that do not meet the requirements of ASC 280-10-50-30 and 50-31. For example, ASC 280-10-50-30(a) requires a public entity to reconcile the “total of the reportable segments’ revenues to the public entity’s consolidated revenues,” and ASC 280-10-50-30(b) requires a public entity to reconcile the “total of the reportable segments’ amount for each measure of profit or loss to the public entity’s consolidated income before income taxes and discontinued operations.” To meet the requirements of ASC 280-10-50-30(a) and (b), an entity needs to (1) provide subtotals that respectively aggregate the revenues for all reportable segments and the profits or losses for all reportable segments and (2) reconcile such subtotals to the corresponding consolidated amounts. Failure to do so, or the inclusion in a subtotal of amounts unrelated to the segments (e.g., corporate expenses), has been subject to comments from the SEC staff.

The SEC has also commented on segment reconciliations that present “corporate and all other” in a manner consistent with a reportable segment, observing that “corporate” or “other” does not represent a reportable segment and should be excluded from the reportable segment total in accordance with ASC 280-10-50-15 and ASC 280-10-55-48. For components that are not reportable segments (e.g., corporate headquarters or certain functional departments, other business activities, or operating segments), a public entity may not recognize revenues or may recognize revenues that are only incidental to the entity’s activities for these components. Such components would be presented as items that reconcile the reportable segment total to the total consolidated pretax income from continuing operations (or to net income, if the public entity allocates income taxes to segments).

In November 2023, the FASB issued ASU 2023-07 to improve the information that a public entity discloses about its reportable segments and to address investor requests for additional disclosures about segment expenses. The ASU does not change existing guidance on the identification of operating segments, the manner of determining reportable segments, or the aggregation criteria. Rather, it adds disclosure requirements that also apply to entities with a single reportable segment, not just those with multiple reportable segments.

ASU 2023-07 introduces the significant expense principle, which requires an entity to provide additional disclosure of segment expenses. It also enhances interim disclosure requirements, clarifies the circumstances in which an entity can disclose multiple segment measures of profit or loss, and adds certain other new disclosure requirements.

The ASU became effective for all public entities for fiscal years beginning after December 15, 2023 (e.g., for calendar-year-end public entities, annual periods beginning on January 1, 2024 [December 31, 2024, for Form 10-K]), and interim periods within fiscal years beginning after December 15, 2024 (e.g., for calendar-year-end public entities, interim periods beginning on January 1, 2025 [the first quarter of 2025 for Form 10-Q]). The enhanced segment disclosure requirements apply retrospectively to all prior periods presented in the financial statements.

Calendar-year-end public companies were required to adopt the ASU’s changes in their 2024 Form 10-K filings. Segment reporting remains a significant source of SEC comments, and the SEC staff has indicated that it is focusing on registrants’ compliance with the ASU’s disclosure requirements.