My Cpa Is Disclosing Information to a Family Member.
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| LARRY DEPPE, CPA, PhD, CMA, is associate professor of accounting at Weber Land University in Ogden, Utah. His e-mail address is ldeppe1@weber.edu . Due south. CRAIG OMER, CPA, is a partner with KPMG in Table salt Lake Urban center. He is a member of the AICPA council. His e-mail service address is comer@kpmg.com . |
or many years, analysts and other users of external fiscal reports take expressed concern most the class and usefulness of the segment reporting companies include in these statements. Analysts believe that agreement the components of a multifaceted enterprise is vital to obtaining a complete understanding of that business concern.
Let'due south start with the 3 R's of quality…relevance, reliability and representational faithfulness.
A high-quality accounting standard requires relevant accounting information. Information is relevant if investors can employ information technology when they make investment decisions. Relevance requires sufficient and appropriate disaggregated information…[and] whether it is provided in sufficient and advisable ways, showing the major risks and rewards associated with components of the business organization to let the reasonable investor to make reasonable decisions about the business concern as a whole equally afflicted 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 Written report Card for Loftier-Quality Financial Reporting," delivered by Lynn E. Turner, main accountant, SEC, at the Hylton Lecture Serial in Accountancy, Wake Forest University, April 25, 2000.
Financial statement users expressed great dissatisfaction with the information companies presented in fiscal reports prepared in compliance with FASB Argument no. 14, Financial Reporting for Segments of a Business Enterprise, issued in 1976. Because the definition of an manufacture segment under Statement no. 14 was imprecise (to accommodate a wide variety of businesses bailiwick to the rule) the result was that companies provided only express data. Disclosures made under Argument no. xiv were not helpful to fiscal statement users. In some cases, businesses exploited the imprecision of the industry segment definition to avoid providing useful information.
Both the AICPA Special Commission on Financial Reporting and the Association for Investment Management and Inquiry 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 near Segments of an Enterprise and Related Data.
Argument no. 131 was effective for financial years beginning afterwards December 15, 1997. While information technology appeared, at get-go 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 akin.
Management faces increased competitive hazard equally a result of competitors knowing more nigh the company. Most companies baby-sit data on the profitability of segments advisedly. If besides much information is revealed in fiscal statements, the company could lose its negotiating advantage in an acquisition. Auditors, in plough, face the risk of not knowing how the SEC will reply to disclosures on which the accountant had rendered an stance. If the auditor discloses too much information, the client faces a competitive disadvantage. Disclosing too niggling might raise the ire of the SEC. Prepared properly, however, the required disclosures can prove useful to both direction and argument users, particularly when compared to Argument no. 14.
A number of issues take arisen since companies began applying Statement no. 131, including implementation issues confronting both fiscal managers and outside auditors. To aid CPAs better understand them, this article offers some examples of how some businesses have practical Statement no. 131.
THE BASICS OF THE NEW Arroyo
The exhibit beneath summarizes the requirements of Argument no. 131. The statement adopts a management arroyo to defining segments and uses the term operating segment rather than industry segment. An operating segment is a component of an enterprise
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That engages in business organization activities from which it may earn revenues and incur expenses (including revenues and expenses related to transactions with other components of the enterprise).
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Whose operating results are regularly reviewed by the enterprise'due south principal operating determination maker to decide how to allocate resources to the segment and assess its performance.
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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 data about products and services and about geographic areas of operations for the enterprise as a whole if the bones 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 manner individual concern 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 visitor to measure the data it reports about each segment in the same fashion equally the company's chief operating decision maker uses the information to classify resource to segments and to assess segment functioning. A visitor need non provide segment information in accordance with the GAAP it uses to fix its consolidated financial statements. A company should allocate amounts to a segment on a reasonable ground rather than based on consolidated amounts. Information technology must disembalm any differences in the basis of measurement betwixt the consolidated and segment amounts. If the company allocates an expense to a segment without besides 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 whatsoever 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 data in the same form as the company's chief operating conclusion maker uses it to run the business organisation. External financial statement users will have information that is consistent with that used by a company'south internal system. Since most enterprises already use such information to manage the entity, it should be readily available, thus minimizing costs and the fourth dimension a visitor might spend generating it. Giving outsiders the same information executives employ to operate the enterprise will ostensibly help these outsiders identify the risks and opportunities management deems important. Despite these purported advantages, nonetheless, managers and auditors take found some significant challenges in meeting the segment reporting requirements.
| Result | Statement no. 131 Approach |
| Defining segments | Modified management arroyo. |
| Quantitative thresholds | Report segments constituting 10% or more than of reported revenues, assets, or profit or loss. Reportable segments must account for 75% of external revenues. |
| Limit on number of segments to be reported | Non specifically stated, merely more than than 10 probably too many. |
| Information to exist disclosed about segments | Using the modified direction approach: Internal and external revenues. Profit or loss. Depreciation, depletion and amortization expense. Unusual items. Total assets. Equity in vertically integrated, equity-method investee internet income. Investment in disinterestedness-method investees. Total capital expenditures (additions to property, plant and equipment). Information about major customers. Information (revenues, operating profit or loss, identifiable assets) about foreign operations and export sales. Significant noncash items, other than depreciation, depletion and amortization expense:
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| Interim period | Disclosure required of the post-obit items in interim reports:
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| Bookkeeping principles | Segment information may be presented on same basis as reported for internal purposes; disclosure must be made of the ground on which information was prepared, including any differences in the footing of measurement between consolidated and segment amounts. Segment totals must be reconciled to consolidated totals in fiscal statements. |
| Information about major customers | If 10% or more of enterprise revenue is derived from sales to a single customer, disclosure of that fact and the amount of revenue from each such customer is required. |
| Restatement of previously reported data | If an enterprise changes the structure of its internal organization, resulting in a change in the composition of reportable segments, then respective information for earlier periods (including interim periods) should be restated. |
Management IMPLEMENTATION ISSUES
Implementing Statement no. 131 has put new demands on the managers of some enterprises such that they now must step back and inquire: How practice we manage this business? Practice we manage it on the ground of segments? For some managers, the standard requires a different orientation in that they must examine how they see the unabridged company as well as how they view each line of business organisation to appraise each segment's profitability, take a chance and potential.
Direction must identify objectives for the lines of business organisation and how the visitor meets them. In some instances, managers have discovered that the lines of business they use for management purposes practise in fact stand for with the segments divers in Statement no. 131 and that they utilise these segments to manage the business organization.
Conversely, some managers have recognized that they practice not manage on the footing of segments. Indeed, feel has shown that if direction cannot tell the auditor what the segments are, information technology probably does not manage the company past segments. These managers need to identify what they do look at in running the concern and how that data corresponds with the segment concept the standard requires. In some instances, specially in the kickoff year of applying the new rules, managers were faced with converting the information they used into something resembling a segment. The procedure of segment identification and reporting required companies to modify their internal management reporting systems, which cost more in terms of time, coin and internal resource.
One of FASB's primary premises in issuing Statement no. 131 was that nearly businesses would take the required segment data readily available considering they already used it for direction purposes. While this undoubtedly is true of many major corporations, it is less true of smaller enterprises. Contained auditors, therefore, take a major office to play in assisting and educating companies about the evolution of segment information. For companies that exercise not manage, or even think of, their business concern in terms of segments, determining the number and composition of segments can be a difficult task.
Some managers are uncomfortable with Statement no. 131's requirements. Disclosing segment information opens a larger window into a concern' inner workings past allowing outsiders access to more information. Improved segment information may give shareholders a ground for challenging management on retaining or disposing of specific segments. If a segment fails and investors lose money, they volition hold management responsible.
The level of success or failure of the business organization—as portrayed by segment reporting—volition be determined in large measure by how management identifies segments. For case, management may identify segments in such a mode equally to muffle a money-losing operation (peradventure the segment is the CEO'southward pet project). Poor segment performance ultimately reduces the value of the company's debt and equity securities. Investors and creditors are probable to respond forcefully and negatively. Consequently, management must report segments and results accurately, as investors will have little tolerance for errors or deception.
Accountant CONSIDERATIONS
Contained auditors likewise are subject field to new risks and responsibilities equally a result of Statement no. 131. Simply as management must ask itself how the business concern is managed and if it is segmented, auditors must ask the same questions of direction and perform different tests and make added inquiries to substantiate direction'due south responses.
To get the data required for offering an opinion on segment information, auditors must sympathize the nature and operations of the client's business in greater depth than e'er before. Auditors must place the market segments the concern operates in and the dynamics of these markets, every bit well as the competitive bug against the business. They must be aware of key business organization processes as well as direction's operational tools. And they must run across the system every bit management sees it, which means they must have access to the highest management levels.
Auditors traditionally have had access to client personnel at or beneath the CFO level and have had limited interaction with operating managers. To have a basis for expressing an opinion under Argument no. 131, auditors must sit in on direction, board and executive committee meetings. Summit managers, in turn, must empathize the nature of the disclosures and assertions being made and exist honest and forthright with the auditor about what they do. Auditors must help senior management understand that the Statement no. 131 disclosures are not optional. They are role of the GAAP auditors must follow and are a necessary step if a company wants admission to capital markets. Since the nature of the new segment disclosures has changed the level and latitude of admission, auditors demand the knowledge and interpersonal skills to deal with managers at the highest levels, and top management must be cooperative. To do less is to imperil both direction and the auditor.
In forming an opinion on segment disclosures, the accountant must compare the actual methods used with direction'southward description of what they practise. Management presumably uses its description of how it manages the business every bit the ground for segment disclosures. Auditors must determine that management's clarification reflects actual events. Auditors also must trace footnote disclosures for segment information to internal reporting documents that direction produces and uses regularly throughout the yr. External disclosures and internal data must exist consistent.
The auditor must examination allocations to identified segments for propriety and accurateness. The auditor likewise must determine that the standard's quantitative thresholds are met and that all required disclosures have been made. Additionally, the auditor should identify risks specific to any segment, such every bit environmental risks.
Testing segment disclosures requires extra work and extra fees. Companies conspicuously will not welcome the latter. Many companies do not see the benefits of the segment disclosures (particularly nonpublic companies whose managers have shown a distinct aversion to any voluntary disclosure of segment information). They are particularly concerned about divulging information on the profitability of segments. Auditors must exist sensitive to these concerns while gathering the show necessary to support an stance on segment disclosures and the company'south compliance with professional person standards. Auditors may have to help their clients empathize that the boosted data Argument no. 131 requires adds value to the fiscal statements. Without the disaggregation the pronouncement requires, no means exists for analysts and others to predict the overall amounts, timing or risks of the entire enterprise'southward cash flows.
THE Correct DECISION
In implementing Statement no. 131, unlike problems arise based on each company's peculiarities. Complying with the standard requires considerable judgment and conscientious assay of how a business is managed and how decisions are made. No single model will apply to every industry. Consider the following examples.
Case 1. Banks A and B are regional banks. Bank A manages by geographical segments (by states in which the bank operates). It has a president and an executive management grouping responsible for each region. Human being resources, investment capital and other resource are allocated geographically. Financial reporting flows through the organization based on geographic structure. Although the company reports secondary information along business and product lines, direction runs the concern based on geography.
Depository financial institution B, on the other manus, uses a more traditional management arroyo for the industry—lines of business. Banking concern B has the following reportable segments based on its business organization lines: community banking, retail lending, business banking, upper-case letter markets, treasury, investment management and parent and other.
Case 2. Company C is in the oil and gas industry and will presently complete a public offering of debt securities. It has "downstream" businesses in the grade of a refinery, retail fuel sales, truck stops, convenience stores, restaurants and motels. The company sells the fuel information technology refines to its own retail fuel outlets and truck stops. Information technology has divers separate segments for its refinery and retail operations, has carve up management groups for refining and retailing and detached fiscal reporting for each segment, nonetheless, major competitors such every bit Chevron, Conoco and others with similar downstream operations report all downstream operations as one segment.
Case 3. Visitor D operates several restaurants based on different concepts, including a Mexican caf, a steak house and a Chinese buffet. This company deploys assets, measures profit and loss and defines segments past eating place concept.
Example 4. Company E is in the physical therapy market. It operates plants and sells products in one western state and in the southeast. Ane product line applies electricity to muscle injuries to stimulate tissue regeneration. Another is a device to rearrange cellulite. A 3rd product line consists of therapy tables sold to physical therapists and chiropractors. Still some other line is soft appurtenances, such as knee braces. Interestingly, the company reports all of its products equally 1 segment. Management sees the company equally i line of business addressing a common customer base through the same distribution system. Headquartered in the western state, the company makes decisions on all lines of business based on consolidated information. Budgeting is based on the entire company, merely revenue for the different lines is budgeted separately.
Example 5. Company F is a public company with 3 bones products: a line of flashlights, household goods (manufactured by another visitor) and telephone accessories (primarily represented by a telephone shoulder pad). This company has identified a separate segment for each product line and reports separate profit and loss information for all iii. Different managers oversee each line and brand meaning operating decisions. The visitor allocates resources based on product line.
THE SEC ON SEGMENT DISCLOSURES
The SEC has formally adopted technical amendments to bring its rules on management's discussion and assay and the description of the business into conformity with Statement no. 131. The interim reporting requirements in Statement no. 131 are at present required for fiscal statements filed on form 10-Q and 10-QSB. The commission has not limited itself to these formalities, however.
The SEC has said its staff may challenge a registrant's determination that a component is not a segment for purposes of Statement no. 131 if the chief operating decision maker receives reports on the component'south operating results on a quarterly or more than frequent basis (unless reports of other overlapping sets of components more conspicuously represent how the business is managed). The SEC has, on occasion, requested copies of all reports furnished to the primary operating decision maker when the reported segments did non announced realistic relative to management'due south cess of a visitor's performance or when they conflicted with the chief operating officer'due south public statements. The SEC staff too has reviewed analysts' reports, press interviews by management and other public information to evaluate the consistency of such information with segment disclosures in the financial statements. When inconsistencies appeared, the SEC required registrants to amend their filings to comply with Argument no. 131.
The SEC has advised registrants to be sure to place the products and services from which each reportable segment derives its revenues. Registrants also should report total revenues from external customers from each product or service or each grouping of similar products and services. Further, the commission says it will require disaggregation of disclosures of products and services that are not substantially like and will object to overly broad views of what constitutes a similar product. It will utilise public disclosures and marketing materials describing a registrant's products to decide whether a company has aggregated dissimilar products.
The SEC advises registrants to quantify and explain each material reconciling item in the reconciliation of segment elements to consolidated financial statements. Registrants should identify the effects of measurement differences and explain asymmetrical allocations among segments.
Development
Companies implementing Statement no. 131 face several important problems, amid them the dissimilar approaches to segment reporting. Statement no. 131 requires judgment and conscientious analysis from both direction and the auditor of how a business is managed and how managers make decisions. The SEC has weighed in with its opinions and managers and auditors should take annotation of its views. One thing seems articulate: Segment reporting is however in the development stage. Managers and auditors probable will still have to devote time and effort to this evolving area of financial reporting.
Source: https://www.journalofaccountancy.com/issues/2000/sep/disclosingdisaggregatedinformation.html
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