Update on Segment Reporting Proposal
- September 14, 2022
- Posted by: Hood & Strong
- Category: Tax
On July 27, 2022, the Financial Accounting Standards Board (FASB) voted 5 to 2 to issue a proposal to revise segment reporting. The underlying objective would be to provide investors with more insight into how companies manage their businesses and how management evaluates performance. Here are the details.
What changes will be included in the proposal?
The term “segment reporting” refers to the reporting of the operating units of a company in its financial statements. Segment reporting is required for public companies but not for private entities.
Under U.S. Generally Accepted Accounting Principles (GAAP), companies have to report a segment if it has at least:
- 10% of revenue,
- 10% of the profit or loss, or
- 10% of the combined assets of the company.
Under the proposal, companies would disclose segment expense information based on what the chief operating decision maker (CODM) deemed to be material. The proposal would provide a disclosure principle based on the significant segment expense categories regularly provided to the CODM and included in the reported measure of segment profit or loss.
The proposal also would permit a company to report multiple measures of a segment’s profit or loss. If more than one measure is used, the company would be permitted to disclose any of those measures as long as at least one is determined in accordance with the measurement principles most consistent with those used in measuring the consolidated financial statements. Some FASB members fear this would encourage companies to use non-GAAP profit measures beyond those commonly allowed today.
The FASB also decided to add the following two disclosures:
- The title or committee that’s deemed to be the CODM. This could be an individual or a group.
- The nature of the expense information the CODM uses to manage segment operations. For example, the company may disclose that the CODM uses consolidated or budgeted expense information. This change applies only to public companies that don’t regularly provide segment expenses to the CODM.
These additions would significantly expand what’s required today under Topic 280, Segment Reporting.
How much would implementation cost?
According to the FASB, its proposal would improve the current disclosure requirements under Topic 280 at no major cost to companies. The most commonly cited costs and complexity expected for financial statement preparers include:
- The cost to design and execute internal controls over the significant expense information,
- Additional audit costs, and
- Additional personnel time and costs.
Further concerns were raised about the potential for competitive harm. However, FASB Chair Richard Jones called this proposal the “single largest improvement to segment reporting” that’s been made in over two decades. He believes that the “through-the-eyes-of-management” approach is “one of the best ways for management and investors to communicate about the performance of a business.”
Why did two members dissent?
Not everyone views the proposal as favorably as Jones, however. FASB members Christine Botosan and Gary Buesser, the two dissents, said the revisions didn’t go far enough. Buesser, an analyst, dissented because he believes investors want more segments and more information per segment — but “we’re not including anything on more segments.” He also said that the CODM approach is fundamentally flawed by giving companies a wide latitude on what they report. He called it an “antiquated approach” that’s out-of-touch with today’s business environment.
Similarly, Botosan isn’t convinced that the proposal would improve the usefulness of segment information for making investment decisions. “Half the preparers that were included in the outreach said that their CODM doesn’t receive on a regular basis significant expense information — I find that concerning because it suggests that the principle is not going to include segment disclosures for a large portion of entities,” she said. In addition, she’s worried that the principle can be circumvented easily by strategically selecting the measure of segment profit to which it’s applied, or by altering internal reports to ensure that segment expenses reported to the CODM are kept outside of the selected measure of segment profits.
Once the FASB issues its proposal, the public will get 75 days to submit comments. After it receives public comment, the FASB will redeliberate. Contact Hood & Strong for the latest developments on this issue.
Sidebar: Disaggregating the income statement
The top 100 U.S. companies skimp on disclosing information about salaries and other benefits, according to discussions during a recent Financial Accounting Standards Board (FASB) meeting. As a result, the FASB is now studying a plan that could require companies to break out more information in income statements about labor costs — expenses that can amount to up to 60% of revenue. “Labor costs are something that a broad spectrum of investors have been requesting for a significant amount of time, so in my mind let’s make labor costs explicit rather than implicit,” said FASB member Fred Cannon.
At minimum, companies could be required to disaggregate employee compensation, depreciation and amortization from all expense captions presented on the face of the income statement. This could be supplemented by a break-out of any remaining expenses using a qualitative threshold or principle.
The scope of the income statement disaggregation project includes the following expense captions:
- Selling, general and administrative (SG&A) expenses,
- Cost of services and other costs of revenue, and
- Cost of tangible goods sold.
At this time, no decisions have been made related to this project — and there’s little consensus about the best approach to tackle it. Additionally, some FASB members have expressed concerns that efforts to disaggregate income statement expenses would ultimately require systems changes for some companies, resulting in added costs. Others want to require more consistency in financial reports, which means differentiating the types of costs explicitly. However, a key challenge is devising a principle that everyone can agree on. Stay tuned for more information.