White Paper: FASB Update to Segment Reporting (Topic 280) – Enhancing Financial Transparency

Introduction:

Segment reporting under ASC 280 (as amended by ASU 2023-07) was issued by the Financial Accounting Standards Board (FASB) as a way of providing stakeholders with increased detailed information to understand the different elements driving an entity's financial performance. ASC 280 mandates public companies to disclose financial and descriptive information about their operating segments, and measures of the segments’ profit or loss that the chief operating decision maker (CODM) uses to assess performance and make resources allocation decisions.

This white paper discusses the key elements of ASC 280, as amended by ASU 2023-07, the criteria for identifying reportable segments, the required disclosures, and the challenges and benefits of segment reporting.

(A) Summary of Changes Made in the Most Recent Update

The November 2023 FASB update to Segment Reporting (Topic 280) introduced several critical changes aimed at improving transparency and decision-useful information for investors. These updates emphasize more detailed segment disclosures, greater alignment between internal management reporting and external disclosures, and the inclusion of non-GAAP metrics alongside traditional GAAP reporting.

Enhanced Metrics and Granularity

One of the primary changes in the 2023 update is the requirement for enhanced metrics to provide greater detail about each reportable segment. Companies are now required to disclose additional segment performance indicators that go beyond just revenue, profit, and assets. The aim is to offer stakeholders a more comprehensive view of how different segments contribute to overall company performance. Examples of enhanced metrics include:

• Revenue by product line or service offering: Companies must now break down revenue further into categories, such as product lines or services within a segment. For example, a technology company may disclose segment revenue by software licensing, cloud services, and consulting services, instead of a single aggregated number.

• Profitability by region: Multinational corporations may now be required to provide segmented profitability by geographic region. For instance, a consumer goods company might disclose its gross margin or operating income by region, such as North America, Europe, and Asia-Pacific.

• Capital expenditures and asset utilization: In capital-intensive industries like manufacturing or utilities, companies are required to disclose segment-level capital expenditures and asset utilization rates, helping investors understand where the company is allocating its resources and how efficiently those resources are being used.

• Cost structures and margin breakdowns: Disclosing specific cost structures at the segment level allows for a more in-depth analysis of operating costs and gross or net margins. For example, in the healthcare sector, companies might disclose how operating costs like R&D, labor, and equipment expenses impact segment profitability.

Alignment with Management’s Internal Evaluation

A major focus of the update is ensuring that the segment information reported to external stakeholders mirrors the information management and the CODM use internally to assess performance and allocate resources.  

Examples of this alignment include:

• Internal Performance Metrics: If management uses specific key performance indicators (KPIs) internally to assess segment performance, such as return on investment (ROI), EBITDA margins, or customer acquisition costs, these same metrics should now be reflected in the external segment disclosures. For instance, a telecommunications company that internally tracks average revenue per user (ARPU) for its wireless segment must now disclose ARPU as a segment performance metric externally.

• Resource Allocation and Decision-Making: If a company allocates resources to segments based on factors like cash flow generation or customer growth rate, these factors should now be highlighted in the segment disclosures. For example, if the company has decided to invest more heavily in a high-growth segment based on customer metrics, it should clearly communicate this rationale in its reporting.

• Internal Reporting Structures: Companies may have different ways of internally organizing their segments for managerial purposes. For example, a global company may internally report based on geographic regions, while externally, it previously reported only by product lines. Under the new rules, this discrepancy must be addressed, and the external reporting should be realigned with how management views the business.

Examples of Disclosures Over Rationale for Non-GAAP Measures

Another significant requirement in the 2023 update is the expanded disclosure around the use of non-GAAP financial measures. Many companies use non-GAAP measures to evaluate and communicate performance internally, such as adjusted EBITDA, free cash flow, or core operating income. The update now requires that these non-GAAP measures be reconciled to their closest GAAP equivalents, and companies must explain the rationale for using them in segment evaluations.

Common examples include:  

• Adjusted EBITDA: A company might use adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization, excluding restructuring costs) to measure segment profitability. In its disclosures, the company would need to:

1. Reconcile adjusted EBITDA to the GAAP measure of net income or operating income.

2. Provide a detailed explanation for why adjusted EBITDA is used internally, for example: "We use adjusted EBITDA as a primary metric because it eliminates the effects of non-recurring items and non-operating factors, providing a clearer view of the ongoing profitability of our segments."

• Free Cash Flow: A  company might use free cash flow as a measure of the cash available for reinvestment and distribution to shareholders within each segment. The company would reconcile free cash flow to the GAAP measure of operating cash flow and explain: "We use free cash flow as it better reflects the funds available for strategic initiatives after capital expenditures, which are significant in our retail expansion efforts."

(B) Expedients or Exemptions

To balance the need for increased disclosure with the burden on preparers, FASB has provided several practical expedients:

• Materiality Thresholds: Companies are permitted to exclude certain segments from detailed disclosure if the segment’s contribution to overall performance is immaterial. This threshold is intended to prevent overwhelming investors with insignificant data.

• Interim Reporting Simplifications: Companies may opt to provide less detailed segment reporting in interim periods, particularly if significant changes in segment performance are not anticipated between annual and quarterly reports.

• Non-Public Entity Relief: Non-public entities may not be required to provide the same level of segment reporting as public companies. This exemption recognizes the lesser need for detailed financial information for non-public entities' stakeholders.

These exemptions and expedients are designed to ensure that the benefits of increased disclosure do not impose unnecessary compliance costs.

(C) Reporting Deadlines

The new ASU becomes effective for fiscal years beginning after December 15, 2024. Early adoption is permitted, allowing companies to implement the changes as soon as they are ready. Public entities are encouraged to begin preparing early for these changes, especially if they anticipate significant adjustments to their internal reporting structures or disclosure processes.

For companies that wish to adopt early, it’s recommended to complete a thorough analysis of existing segment disclosures, reconciling them with the new requirements. This will ensure smooth compliance once the standards become mandatory.

(D) Advice, Tips, and Tricks

To navigate the changes introduced by the 2023 update, companies should consider the following best practices:

1. Align internal reporting early: Begin by ensuring that internal segment performance evaluations are well-aligned with external reporting. This may involve updating internal accounting systems to track the newly required metrics and ensuring consistency between internal reports used by management and those disclosed externally.

2. Engage stakeholders early: Since segment reporting is often scrutinized by analysts and investors, engaging with these stakeholders early in the process is beneficial. Understanding their expectations regarding segment data can help in shaping disclosures in a way that meets their needs while complying with FASB’s requirements.

3. Prepare for enhanced reconciliations: With the new emphasis on reconciling non-GAAP measures, ensure that your accounting team is prepared to link these performance measures to GAAP figures clearly and accurately. This may involve additional training or the development of internal tools for managing reconciliations.

4. Leverage technology for reporting: Many companies are now using ERP systems that can help automate and streamline segment reporting. For example, enhanced reporting modules within ERP systems like SAP, Oracle, or NetSuite can help manage the increased complexity of segment disclosures and ensure timely and accurate reporting.

5. Early adoption to build goodwill: If feasible, consider early adoption of the new standards. Demonstrating a proactive approach to transparency can build goodwill with investors and other stakeholders, showcasing the company’s commitment to high-quality financial reporting.

6. Seek professional guidance: As with any significant accounting change, it may be helpful to seek external advice, especially regarding compliance with non-GAAP measures and the integration of segment reporting into broader financial statements.

Conclusion

The November 2023 update to Segment Reporting (Topic 280) represents a critical shift in how companies disclose segment performance, aiming to provide more granular and decision-useful information. By preparing early and leveraging practical expedients where necessary, companies can ensure smooth compliance with the new standards while maintaining the confidence of their stakeholders.

These changes, while adding complexity, ultimately enhance the transparency and comparability of segment reporting, benefiting investors, analysts, and management alike. Reach out to a Solaris consultant today for assistance managing the enhanced segment reporting guidelines.

References

1. Financial Accounting Standards Board (FASB), ASC 280, as amended by ASU 2023-07

2. KPMG, Segment Reporting (post-ASU 2023-07) Executive Summary – July 2024