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Financial Reporting and the Law

A frequent area for SEC staff comment involves the way in which a company reports its segments in its financial statements filed with the SEC. Periodically, the SEC staff will ask to see copies of financial information for the various components of the business that a company’s chief operating decision maker (CODM) receives on a regular basis. This is because an “operating segment”—as defined by the FASB’s Accounting Standards Codification (ASC 280-10-50-1)—is, in general, a component of a public entity for which discrete financial information is available and whose operating results are regularly reviewed by the CODM to make resource allocation decisions and evaluate performance.

Historically, companies have not been able to satisfy the SEC staff that a CODM who has received financial information for a component of a business is not using that financial information to make resource allocation decisions or to evaluate performance relating to that business component. Given advances in technology, companies are now able to easily provide more detailed financial information to the CODM electronically than they included in the hard copies of financial information that they formerly provided. Not only can the information be furnished electronically, but it can include links for the CODM to access more detailed financial information. This increasing availability of financial information may further complicate the burden on companies to justify their reportable segments when the CODM is able to access detailed revenue and profitability information for components of reportable segments.

The aggregation of operating segments can also be challenging to defend. Both qualitative and economic factors must support a company’s aggregation of operating segments into fewer reportable segments. The economic characteristics must be similar, and a 5% difference between the gross margins of two operating segments may be too great to support aggregation.

The SEC staff emphasized that it was focusing on segments at the AICPA conference in December 2013. In addition, an SEC enforcement case—which was filed in June 2013 against PACCAR after several rounds of SEC staff comments about the company’s classification of segments, including a no further comments letter—is further evidence that the SEC is taking segments seriously.