Business Line Reporting Revamp Leaves Investors Wanting More

It’s billed as the most significant change to segment reporting in financial statements since 1997, but to the investors and analysts waiting years for improvements to the way companies report their major business lines, it falls far short.

The Financial Accounting Standards Board’s proposal calls on companies to break out new details about significant expenses in their operating segments—but it tinkers with existing rules rather than overhauling them. It also injects extra flexibility into an already judgment-laden set of rules, analysts and investors are telling the US accounting rulemaker.

“It’s not something that I think is a game changer or something investors are going to be excited about in its current structure,” said David Gonzales, senior accounting analyst at Moody’s Investors Service. “We can’t say it will provide better information to investors.”

The October proposal calls on public companies to break out the significant expenses in their operating segments—units within a company that earn money and incur expenses. The proposal does not define what “significant” means, another area of heartburn for analysts, as well as auditors who have to vet company numbers.

Some large companies, such as Nike Inc., break out their operating segments by where in the world they sell their products, while others, like Gap Inc. definethem by individual brands, such as Old Navy and Banana Republic. The division of segments is based on whether a company’s management regularly reviews the results of the individual units.

Companies have broad discretion to figure out how to divide their segments—or whether they need to divide them at all. One third of all public companies, such as Netflix Inc., report only one operating segment. Companies must separately report the profit or loss within these business units, but they’re not required to break down expenses like payroll or costs of goods sold.

That’s where FASB’s proposal comes in. Companies would have to report significant expense details every reporting period—not just annually—and even businesses that report a single segment would have to comply. New expense details will help financial statement readers glean key insight into the costs that drive financial performance and help investors make better forecasts, proponents say.

“I can’t see any vision in which investors won’t end up with more information under this project,” FASB Vice Chair James Kroeker said in July, when FASB was crafting the plan.

But investors don’t just want more information; they want information that’s as consistent as possible from company to company. The flexibility baked into the proposal—relying on management to self-identify “significant” expenses—is a problem, said Todd Castagno, head of global valuation at Morgan Stanley’s research division.

“It’s the range of outcomes we’re going to get. It’s very uncertain,” Castagno said.

U-Haul Holding Co. made a similar point. Because every company breaks down its segments in a different way, expense disclosure won’t be consistent among companies, potentially even in the same industries, the company told FASB in a recent comment letter. U-Haul’s largest reportable segment is moving and storage, for example, but that segment may be the smallest for its competitors.

Rooted in Judgment

The segment accounting standard, ASC 280, is rooted in judgment; a company’s management has wide berth to figure out how to break out its segments. The Securities and Exchange Commission frequently presses companies to reveal more when the regulator reviews company financial statements, while businesses are often leery of providing sensitive information to competitors.

“Almost from the beginning, the financial analysts said, ‘Thank you very much, but this is not quite enough,’” said Dennis Beresford, accounting professor at the University of Georgia, and chair of FASB from 1987 to 1997, when the first segment rules were issued. “Over time, every time the different surveys were made of the investment community, that’s been No. 1 on their wish list—to improve the segment disclosures.”

FASB in 2017 started looking at ways to improve segment reporting by forcing more segment breakdowns. By 2020, it had narrowed its focus to build upon what’s already required.

The California Public Employees Retirement System, the largest public pension fund in the US, expressed disappointment about where FASB ended up.

“Put simply, we would have preferred the FASB take a larger step in line with its mission and caused companies to provide substantially more information,” the fund wrote in a comment letter to FASB. The fund said it would “reluctantly” support the proposal only because asking FASB to take a new approach would mean “another several years” of waiting.

Additional Insight

Companies currently are required to disclose the profit or loss in their operating segments. The measure companies report doesn’t have to align with U.S. generally accepted accounting principles, or GAAP, if that’s how management assesses the unit.

But the measure also has to be one that is closely aligned to US accounting rules. So, if Gap Inc.'s CEO measures Old Navy’s performance using EBITDA—earnings before interest, tax, depreciation and amortization, and one of the most common non-GAAP measures—then that number can be reported in the segment disclosure as long as the company reconciles it, or maps it back, to the official, consolidated financial results.

Under FASB’s plan, companies that use multiple ways to assess segment performance would be allowed to report these extra measures, including more non-GAAP measures. Two FASB members—Christine Botosan and Gary Buesser—dissented in part because of concerns about explicitly allowing more alternative measures in the financial statement footnotes.

This caught the attention of a panel at the American Institute of CPAs, which also raised concerns about more non-GAAP measures. The proposal doesn’t expressly prohibit a company from using a more unusual, or tailored number, such as the kind that the SEC frowns upon in earnings releases that undo official accounting, said Angela Newell, deputy managing partner at BDO USA LLP and chair of the AICPA panel.

“It’s one thing to add or subtract things that are accounted for in accordance with GAAP, it’s another thing to change GAAP, so to speak,” Newell said. “Right now, this proposal doesn’t include those guardrails or prohibitions.”