In this article we will discuss about:- 1. Introduction to Segment Reporting 2. Guidelines for Segment Reporting 3. Information to be Disclosed by Operating Segment 4. Explanation of Measurement.

Introduction to Segment Reporting:

To facilitate the analysis and evaluation of financial data, in the 1960s several groups began to push the accounting profession to require disclosure of segment information. Not surprisingly, the timing of this movement corresponded to a period of significant corporate merger and acquisition activity. As business organizations expanded through ever-widening diversifica­tion, financial statement analysis became increasingly difficult.

The broadening of an enter­prise’s activities into different products, industries, or geographic areas complicates the analysis of conditions, trends, and ratios. The various industry segments or geographic areas of an enterprise’s operations can have different rates of profitability, degrees and types of risk, and opportunities for growth.

Because of the increasingly diverse activities of many organizations, disclosure of additional information was sought to help financial statement readers. The identity of the significant elements of an entity’s operations was viewed as an important complement to consolidated totals.


Thus, organizations such as the Financial Analysts Federation, the Financial Executives Institute, and the New York Stock Exchange supported the inclusion of data describing the major components (or segments) of an enterprise as a way to enhance the informational content of corporate financial statements.

The move toward dissemination of disaggregated information culminated in December 1976 with the FASB’s release of SFAS 14, “Financial Reporting for Segments of a Business Enterprise.” This pronouncement established guidelines for the presentation within corporate financial statements of information to describe the various segments that constitute each reporting entity.

Guidelines for Segment Reporting:

SFAS 14:

Specifically, SFAS 14 required financial information to be presented portraying as many as four distinct aspects of a company’s operations.


1. Industry Segments:

To disclose for each reportable industry segment:

i. Revenues

ii. Operating profit or loss


iii. Identifiable assets

iv. Aggregate amount of depreciation, depletion, and amortization expense

v. Capital expenditures, and

vi. Equity in the net income from an investment in the net assets of equity investees.


2. Domestic and Foreign Operations:

To disclose for domestic operations as well as for opera­tions in each significant foreign geographic area:

i. Revenues.

ii. Operating profit or loss.


iii. Identifiable assets.

3. Export Sales:

To report for domestic operations the amount of revenue derived from export­ing products to unaffiliated customers in foreign countries.

4. Major Customers:


To disclose the amount of revenue derived from sales to each major customer. Most companies made this information available within the notes to the financial statements. A substantial body of academic research empirically investigated the usefulness of SFAS 14 disclosures.

Some of the major findings are these:

i. Industry segment data improve analysts’ accuracy in predicting consolidated sales and earnings; this is true for both large and small firms.

ii. The availability of industry segment data leads to greater consensus among analysts regard­ing their forecasts of sales and earnings.


iii. Segment revenue data (both industry and geographic) appear to be more useful than seg­ment earnings data in making forecasts.

iv. Stock market participants use the initial disclosure of geographic area data in assessing the riskiness of companies with foreign operations.

When considered as a whole, the extant research clearly indicates that SFAS 14 segment data were useful to investors and creditors in evaluating the risk and return associated with invest­ment or lending alternatives.

Notwithstanding the fact that in complying with SFAS 14 companies provided information useful to external users of financial statements, financial analysts consistently requested that information be disaggregated to a much greater degree than was done in practice. In its 1993 position paper Financial Reporting in the 1990s and beyond, the Association for Investment Management and Research (AIMR) indicated, “There is no disagreement among AIMR mem­bers that segment information is totally vital to their work.

There also is general agreement among them that the current segment reporting standard, Financial Accounting Standard No. 14, is inadequate.” The AICPA’s Special Committee on Financial Reporting echoed this sentiment by stating that “[users] believe that many companies define industry segments too broadly for business reporting and thus report on too few industry segments.”

Both the AIMR and the AICPA’s special committee recommended aligning segment report­ing with internal reporting by defining segments on the basis of how an enterprise is organized and managed.


Segments based on an enterprise’s internal organization structure would have four advantages:

1. Information on an enterprise’s organization structure is valuable because it reflects the risks and opportunities that management believes to be important.

2. The ability to see the company the way management views it improves an analyst’s ability to predict management actions that can significantly affect future cash flows.

3. Because segment information already is generated for management’s use on the basis of the company’s internal structure, the incremental cost of providing that information externally should be minimal.

4. Segments based on an existing internal structure should be less subjective than segments based on the term industry.

In 1992, at the request of the AIMR, the AICPA Special Committee on Financial Reporting, and others, the FASB and the Accounting Standards Board (AcSB) in Canada decided to jointly reconsider segmental reporting with the objective of developing common standards that would apply in both the United States and Canada.

After several years of study, in January 1996, the FASB issued an exposure draft for a Proposed Statement of Financial Accounting Standards, “Reporting Disaggregated Information about a Business Enterprise.” The AcSB also issued an exposure draft identical in its applicable requirements to the FASB’s proposed statement.

In June 1997, the FASB approved SFAS 131, “Disclosures about Segments of an Enterprise and Related Information.” Effective for fiscal years beginning after December 15, 1997, this statement makes substantial changes to the segment disclosures required to be provided by U.S. companies. How reportable segments are determined, and amount and types of information to be provided significantly changed.

SFAS 131:

According to SFAS 131, the objective of segment reporting is to provide information about the different business activities in which an enterprise engages and the different economic envi­ronments in which it operates to help users of financial statements-

i. Better understand the enterprise’s performance.

ii. Better assess its prospects for future net cash flows.

iii. Make more informed judgments about the enterprise as a whole.

The Management Approach:

To achieve this objective, SFAS 131 adopted the so-called management approach for deter­mining segments. The management approach is based on the way that management disaggre­gates the enterprise for making operating decisions. These disaggregated components are operating segments, which will be evident from the enterprise’s organization structure. More specifically, an operating segment is a component of an enterprise if-

i. It engages in business activities from which it earns revenues and incurs expenses.

ii. The chief operating decision maker regularly reviews its operating results to assess perfor­mance and make resource allocation decisions.

iii. Its discrete financial information is available.

An organizational unit can be an operating segment even if all of its revenues or expenses result from transactions with other segments as might be the case in a vertically integrated company. However, not all parts of a company are necessarily included in an operating seg­ment. For example, a research and development unit that incurs expenses but does not earn revenues would not be an operating segment. Similarly, corporate headquarters might not earn revenues or might earn revenues that are only incidental to the enterprise’s activities and there­fore would not be considered an operating segment.

For many companies, only one set of organizational units qualifies as operating segments. In some companies, however, business activities are disaggregated in more than one way and the chief operating decision maker uses multiple sets of reports. For example, a company might generate reports by geographic region and by product line.

In those cases, two addi­tional criteria must be considered to identify operating segments:

1. An operating segment has a segment manager who is directly accountable to the chief operating decision maker for its financial performance. If more than one set of organiza­tional units exists but segment managers are held responsible for only one set, that set con­stitutes the operating segments.

2. If segment managers exist for two or more overlapping sets of organizational units (as in a matrix form of organization), the nature of the business activities must be considered, and the organizational units based on products and services constitute the operating segments. For example, if certain managers are responsible for different product lines and other man­agers are responsible for different geographic areas, the enterprise components based on products would constitute the operating segments.

Testing Procedures—Complete Illustration:

To provide a comprehensive example of all three of these testing procedures, assume that Atkinson Company is a large business combination comprising six operating segments: auto­motive, furniture, textbook, motion picture, appliance, and finance. Complete information about each of these segments, as reported internally to the chief operating decision maker, appears in Exhibit 8.1.

The Revenue Test:

In applying the revenue test to Atkinson Company’s operating segments the combined revenue of all segments must be determined:

Because these six segments have total revenues of $97.8 million, that figure is used in applying the revenue test. Based on the 10 percent significance level, any segment with revenues of more than $9.78 million qualifies for required disclosure. Accordingly, the automotive, motion picture, and finance segments have satisfied this particular criterion. Atkinson must present appropriate disaggregated information for each of these three operating segments within its financial statements.

The Profit or Loss Test:

Subtracting segment expenses from total segment revenues determines the profit or loss of each operating segment. SFAS 131 does not require common costs to be allocated to individ­ual segments to determine segment profit or loss if this is not normally done for internal pur­poses. For example, an enterprise that accounts for pension expense only on a consolidated basis is not required to allocate pension expense to each operating segment. Any allocations that are made must be done on a reasonable basis.

Moreover, segment profit or loss does not have to be calculated in accordance with generally accepted accounting principles if the mea­sure reported internally is calculated on another basis. To assist the readers of financial state­ments in understanding segment disclosures, SFAS 131 requires disclosure of any differences in the basis of measurement between segment and consolidated amounts.

Each operating segment’s profit or loss is calculated as follows:

The $16.5 million total (the four profit figures) is higher in an absolute sense than the $3.9 million in losses. Therefore, this larger balance is the basis for the second quantitative test.

Because the FASB has again established a 10 percent criterion, either a profit or loss of $1.65 million or more qualifies a segment for disaggregation. According to the income totals just calculated, Atkinson Company’s automotive, furniture, motion picture, and finance segments are large enough to warrant separate disclosure.

The Asset Test:

The FASB’s final test is based on the operating segments’ combined total assets:

Because 10 percent of the combined total equals $4.43 million, any segment holding at least that amount of assets is viewed as a reportable segment. Consequently, according to this final significance test, the automotive, motion picture, and finance segments are all consid­ered of sufficient size to require disaggregation. The three remaining segments do not have sufficient assets to pass this particular test.

Analysis of Test Results:

A summary of all three significance tests as applied to Atkinson Company follows:

Four of this company’s operating segments (automotive, furniture, motion picture, and finance) have been determined to be separately reportable. Because neither the appliance nor the textbook segment has met any of these three tests, disaggregated information describ­ing their individual operations is not required. However, the financial data accumulated from these two non-significant segments still have to be presented. The figures can be combined and disclosed as aggregate amounts in an All Other category with appropriate disclosure of the source of revenues.

Other Guidelines:

Several other FASB guidelines apply to the disclosure of operating segment information. These rules are designed to ensure that the disaggregated data are consistent from year to year and relevant to the needs of financial statement users. For example, any operating segment that has been reportable in the past and is judged by management to be of continuing significance should be disclosed separately in the current statements regardless of the outcome of the test­ing process. This degree of flexibility is included within the rules to ensure the ongoing use­fulness of the disaggregated information, especially for comparison purposes.

In a similar manner, if an operating segment newly qualifies for disclosure in the current year, prior period segment data presented for comparative purposes must be restated to reflect the newly reportable segment as a separate segment. Again, the comparability of information has high priority in setting the standards for disclosure.

One final issue that SFAS 131 raised concerns the number of operating segments that should be disclosed. To enhance the value of the disaggregated information, a substantial portion of a company’s operations should be presented individually. Thus, the FASB has stated that a sufficient number of segments are presumed to be included only if their combined sales to unaffiliated customers are at least 75 percent of total company sales made to outsiders. If this lower limit is not achieved, additional segments must be disclosed separately despite their fail­ure to satisfy even one of the three quantitative thresholds.

As an illustration, assume that Brendan Corporation identified seven operating segments that generated revenues as follows (in millions):

Based on the 10 percent revenue test, four of these segments are reportable (because each has total revenues of more than $7.63 million)- pottery, lumber, appliances, and construction. Assuming that none of the other segments qualifies as significant in either of the two remain­ing tests, disclosure of disaggregated data is required for only these four segments.

However, the FASB’s 75 percent rule has not been met; the reportable segments generate just 62.4 percent of the company’s total sales to unrelated parties (in millions):

To satisfy the 75 percent requirement, Brendan Corporation must also include the lawn mower segment within the disaggregated data. With the addition of this non-significant seg­ment, sales of $38.5 million ($31.3 + $7.2) to outside parties now are disclosed. This figure amounts to 76.7 percent of the company total ($38.5 million/$50.2 million). The two remain­ing segments—housewares and toys—could still be included separately within the disaggre­gated data; disclosure is not prohibited. However, information for these two segments probably would be combined and reported as aggregate amounts.

One final aspect of these reporting requirements should be mentioned. Some companies might be organized in such a fashion that a relatively large number of operating segments exist. The FASB suggests that there could be a practical limit to the number of operating seg­ments that should be reported separately. Beyond that limit, the information becomes too detailed to be useful. SFAS 131 indicates that “although no precise limit has been determined, as the number of segments that are reportable increases above 10, the enter­prise should consider whether a practical limit has been reached.”

Information to be Disclosed by Operating Segment:

Consistent with requests from the financial analyst community, SFAS 131 significantly expanded the amount of information to be disclosed for each operating segment:

1. General information about the operating segment:

i. Factors used to identify operating segments.

ii. Types of products and services from which each operating segment derives its revenues.

2. Segment profit or loss and the following revenues and expenses included in segment profit or loss:

i. Revenues from external customers.

ii. Revenues from transactions with other operating segments.

iii. Interest revenue and interest expense (reported separately); net interest revenue may be reported for finance segments if this measure is used internally for evaluation.

iv. Depreciation, depletion, and amortization expense.

v. Other significant noncash items included in segment profit or loss.

vi. Unusual items (discontinued operations and extraordinary items).

vii. Income tax expense or benefit.

3. Total segment assets and the following related items:

i. Investment in equity method affiliates.

ii. Expenditures for additions to long-lived assets.

SFAS 131 does not specifically require cash flow information to be reported for each oper­ating segment because this information often is not generated by segment for internal report­ing purposes. The requirement to disclose noncash items other than depreciation is an attempt to provide information that might enhance users’ ability to estimate cash flow from operations.

SFAS 131 need not be applied to immaterial items. For example, some segments do not have material amounts of interest revenue and expense, and therefore disclosure of these items of infor­mation is not necessary. In addition, if the internal financial reporting system did not generate information for an item on a segment basis, that item need not be disclosed. This is consistent with the FASB’s desire that segment reporting create as little additional cost to an enterprise as possible.

To demonstrate how the operating segment information might be disclosed, we return to the Atkinson Company example. Application of the quantitative threshold tests resulted in four separately reportable segments (automotive, furniture, motion picture, and finance). The non-significant operating segments (textbook and appliance) are combined in an All Other category. Exhibit 8.2 shows the operating segment disclosures included in Atkinson’s financial statements.

In addition to the information in Exhibit 8.1, data on depreciation and amortization, other significant noncash items, and expenditures for long-lived segment assets were gathered for each operating segment to comply with the disclosure requirements. Only the automotive seg­ment has other significant noncash items, and none of the segments has equity method invest­ments. Atkinson had no unusual items during the year.

To determine whether a sufficient number of segments is included, the ratio of combined sales to unaffiliated customers for the separately reported operating segments must be com­pared with total company sales made to outsiders. The combined amount of revenues from external customers disclosed for the automotive, furniture, motion picture, and finance seg­ments is $61.7 million.

Total revenues from external customers are $71.4 million:

$61.7 million/$71.4 million = 86.4%

Because 86.4 percent exceeds the FASB’s lower limit of 75 percent, Atkinson’s level of disag­gregation is adequate.

Reconciliations to Consolidated Totals:

SFAS 131 does not require provision of disaggregated information in accordance with generally accepted accounting principles. Instead, information is to be provided as the company’s internal reporting system prepares it even if not based on GAAP.

“Preparing segment information in accordance with the generally accepted accounting prin­ciples used at the consolidated level would be difficult because some generally accepted accounting principles are not intended to apply at a segment level”. Examples are accounting for- (1) inventory on a LIFO basis when inventory pools include items in more than one segment, (2) companywide pension plans, and (3) purchased goodwill. Accordingly, allocation of these items to individual operating segments is not required.

However, the total of the reportable segments’ revenues must be reconciled to consolidated revenues, and the total of reportable segments’ profit or loss must be reconciled to income before tax for the company as a whole. Adjustments and eliminations that have been made to develop enterprise financial statements in compliance with generally accepted accounting principles must be identified. Examples are the elimination of intersegment revenues and an adjustment for companywide pension expense. The same is true for reconciliation of total seg­ments’ assets to the enterprise’s total assets.

In addition, in reconciling the total of segments’ revenues, profit or loss, and assets to the enterprise totals, the aggregate amount of revenues, profit or loss, and assets from immaterial operating segments must be disclosed. The company also must disclose assets, revenues, expenses, gains, losses, interest expense, and depreciation, depletion, and amortization expense for components of the enterprise that are not operating segments. This includes, for example, assets and expenses associated with corporate headquarters. See Exhibit 8.3 for an example of how Atkinson might make these reconciliations.

Atkinson Company must make three adjustments in reconciling segment results with consolidated totals. The first adjustment is to eliminate intercompany revenues, profit or loss, and assets that are not included in consolidated totals. The elimination of intersegment revenues includes intersegment transfers amounting to $9.7 million plus $3.6 million of intersegment interest revenue generated by the finance segment.

The second adjustment relates to corporate items that have not been allocated to the operating segments including purchased goodwill, a litigation settlement received by the company, and corporate head­quarters expenses and assets. The third adjustment reconciles differences in segment accounting practices from accounting practices used in the consolidated financial state­ments.

The only adjustment of this nature that Atkinson made relates to the accounting for pension expense. Individual operating segments measure pension expense based on cash payments made to the pension plan. Because GAAP requires measuring pension expense on an accrual basis, an adjustment for the amount of pension expense to be recognized in the consolidated statements is necessary.

Explanation of Measurement:

In addition to the operating segment disclosures and reconciliation of segment results to con­solidated totals, companies also must explain the measurement of segment profit or loss and segment assets including a description of any differences in measuring- (1) segment profit or loss and consolidated income before tax, (2) segment assets and consolidated assets, and (3) segment profit or loss and segment assets. An example of this last item is the allocation of depreciation expense to segments but not of the related depreciable assets. The basis of accounting for intersegment transactions also must be described.

Enterprise-Wide Disclosures:

Information about Products and Services:

The FASB recognizes that some enterprises are not organized along product or service lines. For example, some enterprises organize by geographic areas. Moreover, some enterprises may have only one operating segment yet provide a range of different products and services. To provide some comparability between enterprises, SFAS 131 requires disclosure of revenues derived from transactions with external customers from each product or service if operating segments have not been determined based on differences in products or services.

An enterprise with only one operating segment also must disclose revenues from external customers on the basis of product or service. However, providing this information is not required if impractica­ble; that is, the information is not available and the cost to develop it would be excessive.

Lowe’s Companies, Inc., operates in only one segment; nevertheless, it reported “sales by product category” as required under SFAS 131 in its 2005 annual report. See Exhibit 8.5 for that information.

Information about Geographic Areas:

Two items of information—revenues from external customers and long-lived assets—must be reported- (1) for the domestic country and (2) for all foreign countries in total in which the enter­prise derives revenues or holds assets. In addition, if revenues from external customers attrib­uted to an individual foreign country are material, the specific country and amount of revenues must be disclosed separately as must a material amount of long-lived assets located in an indi­vidual foreign country. Even if the company has only one operating segment and therefore does not otherwise provide segment information, it must report geographic area information.

Thus, the FASB requires U.S.-based companies to disclose the amount of revenues gener­ated and long-lived assets held in- (1) the United States, (2) all other countries in total, and (3) each material foreign country. Requiring disclosure at the individual country level is a signif­icant change from SFAS 14, which required disclosures according to groups of countries in the same geographic area. SFAS 131 does not preclude companies from continuing to provide this information and for consistency purposes, many companies continue to do so even if they determine no single foreign country to be material.

The FASB changed the reporting requirement from geographic regions to individual countries because it believed that reporting information about individual countries has two benefits. First, it reduces the burden on financial statement preparers because most companies likely have material operations in only a few countries, perhaps only their country of domicile. Second, and more important, country-specific information is easier to interpret and therefore more useful.

Individual countries within a geographic area often experience very different rates of economic growth and economic conditions. Disclosures by individual country rather than broad geographic area provide investors and other financial statement readers better information for assessing the risk level associated with a company’s foreign operations.

Although the FASB considered using a 10 percent rule for determining when a country is material, ultimately it decided to leave this to management’s judgment. In determining materiality, management should apply the concept that an item is material if its omission could change a user’s decision about the enterprise as a whole. The FASB does not provide more specific guidance on this issue.

The change in geographic area reporting under SFAS 131 has caused some companies to provide more information than under SFAS 14 and other companies to provide less informa­tion. Exhibit 8.6 presents the geographic area disclosures made by E.I. du Pont de Nemours and Company in its 1997 (last year of SFAS 14) and 1998 (first year of SFAS 131) annual reports.

In complying with SFAS 131, DuPont defined materiality at a very low amount; for example, Mexico generated less than 2 percent of total net sales. By reporting by individual country in 1998, DuPont clearly provided more detailed information than it had provided pre­viously. A limitation in SFAS 131 requirements, however, is that it no longer requires report­ing operating income by geographic area.

See Exhibit 8.7 for International Business Machines Corporation’s geographic area infor­mation reported in its 1997 and 1998 annual reports. As a result of the change from reporting by geographic segment under SFAS 14 to reporting by material country under SFAS 131, IBM provided less detail with regard to the location of non-U.S. revenues. In 1998, the company disclosed the fact that it generated 44 percent of its revenue in the United States and 10 percent in Japan, but it does not disclose the location of the remaining 46 percent of revenues gener­ated in other foreign countries.

Information about Major Customers:

SFAS 131 retained one final but important disclosure requirement originally established in SFAS 14. A reporting entity must indicate its reliance on any major customer. Presentation of this information is required whenever 10 percent or more of a company s revenues is derived from a single customer. The existence of all major customers must be disclosed along with the related amount of revenues and the identity of the operating segment generating the rev­enues. Interestingly enough, the company need not reveal the customer’s identity.

The 2006 annual report for the Briggs & Stratton Corporation is an example of how this information is disclosed. Note 6 to the financial statements indicated: “Sales to the follow­ing customers in the company’s Engine Segment amount to greater than or equal to 9% of consolidated net sales, respectively.” Of 600 companies surveyed in Accounting Trends & Techniques, 136 indicated the existence of a major customer in their 2004 annual reports.

Statement 131 requires major customer disclosures even if a company operates in only one segment and therefore does not provide segment information (as is the case for Briggs Stratton). Also, to avoid any confusion, “a group of entities under common control shall be considered as a single customer, and the federal government, a state government, a local government (for example, a county or municipality), or a foreign government shall each be considered as a single customer”.

In addition to requiring information about major customers, SFAS 14 also required infor­mation about export sales. Providing information on export sales, however, is no longer nec­essary under Statement 131. Accounting Trends & Techniques indicates that the number of companies reporting export sales dropped from 168 in 1997 to only 33 in 2004.