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Segment Reporting

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Introduction

The conceptual framework describes the objective of financial reporting as:

To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. Those decisions including buying, selling, or holding equity and debt instruments and providing or settling loans and other forms of credit (FASB, Concepts Statement No. 8¶ OB2).

In the case of many large entities, however, the reporting entity may include a variety of subsidiaries and units engaged in quite diverse activities. General Electric (GE), for example, identifies more than one hundred subsidiaries in Exhibit 21 of the company’s 2020 SEC filing, Form 10-K. As the business evolves, these activities can and do change. General Electric may be indelibly associated with the light bulb, but the company’s lighting division, along with a long-term license to use the name GE Lighting, was sold to another entity in 2020. The company now has operations that include, among others, aviation (engines, systems, and avionics), healthcare (devices, systems, analytics, and services), home appliances, energy, and financial services. And the company continues to evolve. In 2021, GE announced plans to unwind its once storied GE Capital operations (Gryta, 2021). GE’s financial statements are prepared on a consolidated basis, reflecting the aggregate performance and financial position of the entity as a whole. However, investment and credit decisions may be better informed with supplemental information that is less aggregated. In the case of GE, operations in healthcare and energy may have very different risks, opportunities for growth, and capital requirements. In assessing risk and predicting GE’s future performance, investors would likely find it useful to have reliable information regarding the company’s investments and performance across its varied areas of operations in addition to that aggregated at the entity level.

To help financial statement users evaluate performance of the entity, FASB requires disclosure of segment information in addition to aggregate consolidated financial statements. The SEC also has segment disclosure mandates for public companies under its jurisdiction. Views about and requirements for segment disclosures have evolved over time. Interestingly, segment disclosure continues to be an area where there is demand for more/better information by financial statement users, but contention about appropriate levels and types of mandated information. Segment disclosure was added to the FASB’s technical agenda in 2017, and in early 2021 the Board’s new chair, Richard Jones, highlighted its segment reporting project as one of two topics that have garnered the most interest. Thus, segment reporting appears to be a priority for the FASB (Maurer, 2021).

The History of U.S. Standards Regarding Segment Reporting

Demand for disaggregated segment disclosures pre-dates the FASB. In the United States, accounting guidance has evolved from encouraging voluntary disclosures to specifically mandating disclosures. U.S. standard setters have produced three major documents on the topic of segment disclosures, the latter two of which became U.S. GAAP accounting standards.

1967

APB Statement No. 2, “Disclosure of Supplemental Financial Information by Diversified Companies”

APB Statement No. 2 recommended, but did not require, voluntary disclosure of industry segment information (APB, 1967 ¶¶ 11-13). It represented an attempt by standard setters to respond to changes in the business environment creating greater demand for segment disclosures including growth in more broadly diversified entities, expansion in numbers of investors and publicly held companies, as well as a more prominent role of financial analysts (APB, 1967 ¶¶ 1-6). While the statement recognized the potential usefulness of segment disclosures, it also noted both potential challenges in identifying useful profitability metrics and concerns that decision-useful segment information might involve the revelation of proprietary information (APB, 1967 ¶¶ 7-9).

1976

SFAS 14, “Financial Reporting for Segments of a Business”

SFAS 14 moved beyond encouraging voluntary segment disclosures, and required disclosure of disaggregated information by industry and geographic area. Motivated by the observation that “In recent years, many business enterprises have broadened the scope of their activities into different industries, foreign countries, and markets,” (FASB, SFAS 14 ¶1), this requirement applied to public and private companies regardless of size. At the time, the members of FASB concluded that costs of compliance would not be overly burdensome, even for relatively small entities, as many already accumulated this information for purposes including internal planning and control (FASB, SFAS 14 ¶68). The Board further concluded that the mandated disclosures were insufficiently detailed or specific to pose a significant risk to an enterprise’s competitive position (FASB, SFAS 14, ¶71). In substance, the Board concluded that the information disclosure specified in this standard would be useful, with benefits to users outweighing compliance costs.

Under SFAS 14, industry segments were defined as “a component of an enterprise engaged in providing a product or service… to unaffiliated customers…for profit.” (FASB, SFAS 14 ¶10a). Quantitative thresholds defined reportable segments; generally a segment responsible for more than 10% of the entity’s combined revenue, profit/loss, or identifiable assets was deemed reportable. The standard mandated specific information disclosures for each reportable segment and, in aggregate, for any segments not deemed to be reportable (FASB SFAS 14, ¶11-20). SFAS also required entities with significant foreign operations to disclose disaggregated information by geographic area (FASB SFAS 14, ¶31-38).

1997

SFAS 131: Disclosures about Segments of an Enterprise and Related Information (subsequently codified as ASC 280: Segment Reporting)

SFAS 131, subsequently codified as ASC 280, remains the current standard regarding segment reporting. Like SFAS 14, this standard applies only to public entities, however it took a different approach to segment reporting by mandating a “management approach” in defining segments (FASB SFAS 131, ¶4 and ¶9). This approach required segmentation based on the operating segments used internally and reviewed regularly by the chief operating decision-maker (CODM) for the purpose of resource allocation and performance assessment (FASB SFAS 131, ¶10). Similar to SFAS 14,10% of combined revenue, profit/loss, or identifiable assets is used as a threshold for identifying reportable segments (FASB SFAS 131, ¶ 16-24). While the standard mandates specific information disclosures for reportable segments, some are subject to the caveat of being regularly reviewed by or included in the measures reviewed by the CODM (FASB SFAS 131, ¶ 25-35)

Descriptive Evidence Regarding Segment Disclosure Practices

Botosan, Huffman, and Stanford 2020 provide descriptive analysis of segment reporting practices spanning the period 1976 to 2017. They report that after the adoption of SFAS 14 with its mandated segment disclosures, the percentage of U.S. publicly traded entities reporting segment data increased from 39% to 89%. This percentage declined to 81% after implementation of SFAS 131 and was 75% in 2017. In addition, they report that the average number of segments reported by the largest one-third of entities remained stable over the 40 years after SFAS 14 first mandated disclosures; with an average number of segments consistently falling between 3 and 4. Their finding that only 5% of entities disclose more than 5 segments, is notable, as is their observation that most entities report two or fewer segments with one segment accounting for 50% or more of total segment revenues. They find that only 7% of segment definitions remain unchanged for 10 or more years, and in both the SFAS 14 and SFAS 131 eras, the average length of time that a segment definition remains unchanged is 3.6 years (Botoson et al, 2020).

Current Status of FASB’s Segment Reporting Project

In September 2017, the FASB added a project on segment reporting to the technical agenda. To some extent the impetus for this project extends back to beginnings of mandated segment disclosures, as users consistently extoll the value of disaggregated data, while preparers generally resist calls for more segment disclosure, often citing risk of disclosing proprietary information that could cause competitive harm. The FAF’s 2012 post-implementation review of SFAS 131 included surveys of both financial statement users and preparers, and responses reflected this tension. While the review concluded that “investors use the improved segment information to make judgments about the entity as a whole. However, reported segment information is not always sufficient for their investment decisions. Users would like more segment information (e.g. gross margin and cash flow). Users also might like more consistency across companies in the amount, type, and measurement of information disclosed” while also noting that “some entities might be aggregating segments to reduce transparency because of competitive harm concerns or for other reasons” (FAF, 2012). More proximately, in 2016 the FASB solicited feedback on issues that it should consider including to its technical agenda. Input from respondents to the FASB’s Invitation to Comment, Agenda Consultation suggesting improvements were needed to enhance the decision-usefulness of segment information informed the Board’s September 2017 vote to add a project on segment reporting to its technical agenda (FASB, 2017).

Since being added to the FASB’s Technical Agenda, work on the Segment Reporting project has progressed. The current status of the project and related documents are available on the Segment Reporting Project Update page of the FASB’s website.

Evaluating Current Segment Disclosures of Alphabet Inc. and Microsoft Corporation and the FASB’s Segment Reporting Project

Alphabet Inc., the parent company of Google, engages in a wide variety of business endeavors, and in Item 1 of its Form 10-K it even describes itself as a “collection of businesses.” While the company may be most closely associated with the well-known Google search engine, YouTube, Chrome, and the Android operating system, it is also engaged a wide array of endeavors including those related to healthcare, artificial intelligence, venture capital, and autonomous driving. Alphabet lists five significant subsidiaries in Exhibit 21 of its 2020 Form 10-K.

Microsoft Corporation is perhaps best known as the developer of Windows operating system software, but it now provides a host of services including cloud computing and artificial intelligence. In Item 1 of its 2020 Form 10-K, Microsoft describes itself as a “technology company.” Microsoft lists seven significant subsidiaries in Exhibit 21 of its 2020 Form 10-K.

Alphabet and Microsoft are competitors in some, but not all areas of their business operations. Both companies provide segment information in the footnotes to their financial statements. In 2016 Alphabet began reporting two segments, “Google” and “Other Bets” (Todd and Patnaik, 2016). In 2021 Alphabet announced that it would increase the number of segments reported in its 2020 annual report to include Google Services, Google Cloud and Other Bets (Cherney, 2021). Microsoft has changed the operating segments it reports multiple times, including in fiscal years 2007, 2014, and 2016 (Microsoft Announces Changes to Financial Reporting Structure, 2006, 2015; Microsoft Corporate Conference Call to Discuss the New Reporting Segments, 2013). Since its 2016 fiscal year, Microsoft has reported 3 segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.

References

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