FASB: A Segue to More Segmenting

The standard-setter aims to rework FAS 131 to give investors and analysts a better look into the financial details of conglomerates' business units.
Marie LeoneMay 17, 2007

The Financial Accounting Standards Board is proposing a significant change in how companies present the health of business-unit finances, asking internal accountants to paint a more detailed picture for investors than current segment reporting provides.

At its weekly meeting on Wednesday, FASB agreed to move forward with its project on segment reporting, which ultimately could modify FAS No. 131, the rule defining how segment data is to be reported on the balance sheet. The project is part of a much larger FASB initiative to rework all financial statement presentation.

FASB members plan to issue a “preliminary views” document on segment reporting by the end of the year. After that, it’s likely that investors, auditors, and corporate finance executives will have four to six months to comment on the broad proposal before FASB incorporates the comments into a more-specific rule draft. Although details of the preliminary document still must be hammered out by FASB staffers, in general it would provide a window into the workings of a company’s business units by “disaggregating” results, giving investors and analysts another way to predict cash flows and perform financial analyses.

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“The full monty [of segment reporting] … is that you break out everything — not just operations or sometimes finance,” asserted FASB Chairman Robert Herz. “Basically, [a company] would have to consolidate by segment for each major financial statement,” added Herz.

Consider a conglomerate with three main business units: manufacturing railroad cars, producing medical equipment, and running a commercial credit operation. In theory, FASB would like to see segment reporting that details such items as receivables; payables; intangibles; and property, plant, and equipment for each division. That would let financial-statement users peer inside Coca-Cola’s bottling operations, GE’s turbine business, or Tyco’s medical-device unit, for example. Currently, companies are required only to disclose business unit totals — aggregated numbers related to profit and loss, assets, and revenues, as well as shared services and other overhead items.

Efforts to reform segment reporting are hardly new. FAS 14, which FAS 131 replaced in 1997, required the reporting of segments based on geography and industry, and was criticized for being vague and too easy to circumvent. Analysts complained that it allowed too many companies to present themselves as single-segment firms, even if the reality was far more complex. In response, FAS 131 appeased those critics who wanted to see the company more like management itself saw it. Suddenly, a company had to start reporting the same information it used internally when it evaluated segment performance and allocated resources to its various divisions. The preliminary document being rewritten for this year is a further evolution of FAS 131.

At Wednesday’s meeting, FASB members also said that they would like the preliminary proposal to address inconsistencies in allocations. Board members hope to move toward a presentation format in which business-unit totals equate to the totals reported on the parent company’s consolidated statements. That’s not always the case now, because companies lack consistency when they allocate overhead-related assets and liabilities — or inter-company transfers of goods and services — across business units. The discrepancies that result are expressed in footnotes, and often appear in separate reconciliation columns within the notes, creating what one FASB staffer quipped was “a mish-mash of numbers.”

Looking ahead, FASB would propose scrapping the footnotes altogether and replacing them with a format that requires companies to classify items down to a “reportable segment level.” The concept raises questions — including comparability questions. Might two car companies categorize revenue from their credit financing business in different ways, for example, with one of them identifying revenues as coming from operations, while the other tagged them as coming from financing?

The release of the preliminary proposal at year’s end is expected to mark the beginning of a robust comment period.