or many years, analysts and other users of external financial reports have expressed concern about the form and usefulness of the segment reporting companies include in these statements. Analysts believe that understanding the components of a multifaceted enterprise is vital to obtaining a complete understanding of that business.

The SEC Chief Accountant on Segment Disclosures

Let’s start with the three R’s of quality…relevance, reliability and representational faithfulness.

A high-quality accounting standard requires relevant accounting information. Information is relevant if investors can use it when they make investment decisions. Relevance requires sufficient and appropriate disaggregated information…[and] whether it is provided in sufficient and appropriate ways, showing the major risks and rewards associated with components of the business to allow the reasonable investor to make reasonable decisions about the business as a whole as affected by its component parts.

The level of aggregation/disaggregation of data must serve to enable investors to understand the major risks and rewards associated with the business.

Adapted from “A QT Report Card for High-Quality Financial Reporting,” delivered by Lynn E. Turner, chief accountant, SEC, at the Hylton Lecture Series in Accountancy, Wake Forest University, April 25, 2000.

Financial statement users expressed great dissatisfaction with the information companies presented in financial reports prepared in compliance with FASB Statement no. 14, Financial Reporting for Segments of a Business Enterprise, issued in 1976. Because the definition of an industry segment under Statement no. 14 was imprecise (to accommodate a wide variety of businesses subject to the rule) the result was that companies provided only limited information. Disclosures made under Statement no. 14 were not helpful to financial statement users. In some cases, businesses exploited the imprecision of the industry segment definition to avoid providing useful information.

Both the AICPA Special Committee on Financial Reporting and the Association for Investment Management and Research noted the importance of segment data and the shortcomings of Statement no. 14. The groups stressed the need for a company to present segment data in the same way it organized and managed its business. FASB responded by issuing Statement no. 131, Disclosures about Segments of an Enterprise and Related Information.

Statement no. 131 was effective for fiscal years beginning after December 15, 1997. While it appeared, at first reading, to be straightforward, Statement no. 131 has proven to be quite subtle and complex. Quality disclosures do not come easily. The nature of the required disclosures increases the level of risk for management and auditors alike.

Management faces increased competitive risk as a result of competitors knowing more about the company. Most companies guard information on the profitability of segments carefully. If too much information is revealed in financial statements, the company could lose its negotiating advantage in an acquisition. Auditors, in turn, face the risk of not knowing how the SEC will respond to disclosures on which the auditor had rendered an opinion. If the auditor discloses too much information, the client faces a competitive disadvantage. Disclosing too little might raise the ire of the SEC. Prepared properly, however, the required disclosures can prove useful to both management and statement users, particularly when compared to Statement no. 14.

A number of issues have arisen since companies began applying Statement no. 131, including implementation issues confronting both financial managers and outside auditors. To help CPAs better understand them, this article offers some examples of how some businesses have applied Statement no. 131.

THE BASICS OF THE NEW APPROACH

The exhibit below summarizes the requirements of Statement no. 131. The statement adopts a management approach to defining segments and uses the term operating segment rather than industry segment. An operating segment is a component of an enterprise

That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses related to transactions with other components of the enterprise).

Whose operating results are regularly reviewed by the enterprise’s chief operating decision maker to decide how to allocate resources to the segment and assess its performance.

For which discrete financial information is available.

This definition includes reporting separately segments that sell their products or services primarily or exclusively to other operating segments of the enterprise if management reports these segments separately for decision-making purposes. Statement no. 131 requires information only about reportable operating segments. Companies must disclose additional information about products and services and about geographic areas of operations for the enterprise as a whole if the basic segment disclosures do not provide such information.

FASB developed the new definition in response to user requests about segment reporting. Users asked that segment reporting reflect the way individual business enterprises are organized and managed. While FASB designed the new definition to provide more relevant information to financial statement users, it sacrificed some measure of comparability as a result of the different approaches to managing an enterprise.

Statement no. 131 requires a company to measure the information it reports about each segment in the same way as the company’s chief operating decision maker uses the information to allocate resources to segments and to assess segment performance. A company need not provide segment information in accordance with the GAAP it uses to prepare its consolidated financial statements. A company should allocate amounts to a segment on a reasonable basis rather than based on consolidated amounts. It must disclose any differences in the basis of measurement between the consolidated and segment amounts. If the company allocates an expense to a segment without also allocating the related asset, it must also disclose that fact.

An enterprise also must reconcile the consolidated totals in financial statements to the reportable segment assets, revenues, profit or loss and any other significant segment information it discloses. Statement no. 131 also requires disclosure of limited segment information in condensed financial statements be included in quarterly shareholder reports.

In issuing Statement no. 131, FASB cited the significant advantages of a company’s reporting information in the same form as the company’s chief operating decision maker uses it to run the business. External financial statement users will have information that is consistent with that used by a company’s internal organization. Since most enterprises already use such information to manage the entity, it should be readily available, thus minimizing costs and the time a company might spend generating it. Giving outsiders the same information executives use to operate the enterprise will ostensibly help these outsiders identify the risks and opportunities management deems important. Despite these purported advantages, however, managers and auditors have found some significant challenges in meeting the segment reporting requirements.

Segment Reporting