Improving internal control over segment reporting

The principles of ASC Topic 280 pave the way toward meeting financial reporting objectives.
By Xiaowen Jiang, DBA, and Ling Lin, DBA

Improving internal control over segment reporting
Photo by fotolism_thai/iStock

On Nov. 7, 2016, the SEC instituted and settled a cease-and-desist order against PowerSecure International Inc., alleging it failed to identify and report its segments as required by FASB Accounting Standards Codification (ASC) Topic 280, Segment Reporting. PowerSecure agreed to pay a $470,000 fine to settle the SEC's claims. It is worth noting that in its annual report for 2015, the company acknowledged a material weakness in its internal controls over segment reporting in prior years, which contributed to faulty segment reporting—from 2012 to the first quarter of 2014, PowerSecure disclosed one reportable segment, when it should have identified and reported multiple segments.

PowerSecure is undoubtedly an extreme example. Nevertheless, in light of the SEC's increasing scrutiny over segment reporting, PowerSecure's case may serve as an alert for preparers and auditors to reassess the design and operation of internal control over the segment reporting judgments. Indeed, in the 12-month period ended July 31, 2016, segment reporting ranked high as the fourth-most-common area discussed in SEC comment letters, according to a Deloitte report. Recent SEC staff speeches emphasize that preparers should apply the principles within Topic 280 to ensure their segment disclosure is consistent with the objectives of segment reporting.

Recent SEC investigations and comment letters show the importance of appropriate design and operation of internal control in three areas:

  • Identification of the chief operating decision-maker (CODM);
  • Identification of operating segments; and
  • Aggregation of operating segments.


According to Topic 280, the CODM refers to a specific function within the company that allocates resources to and assesses performance of the segments of a public entity, rather than a manager with a specific title. Identifying the CODM is a critical aspect of segment reporting, as then-SEC Deputy Chief Accountant Dan Murdock said in 2014 that "failing to appropriately identify the CODM would make it highly unlikely you will get to the right answer."

The CODM is often the company's CEO or COO; however, Topic 280 does not require the CODM to have ultimate decision-making authority. Furthermore, the distinction between any strategic and operating decisions is important as the latter pertains to the entity's day-to-day operational decisions. The identified CODM evaluates the entity's operating results to assess performance and to allocate resources. For instance, in its comment letter to NRG Energy Inc., dated Aug. 20, 2015 (File No. 001-15891), the SEC Division of Corporate Finance stated:

We note your East, West, and Gulf Coast Regional Presidents directly report to your CEO who is also your CODM. Further, we note these Regional Presidents attend meetings with your CEO as well as your NRG Business segment manager. Please tell us in more detail how you considered the guidance in ASC [Paragraph] 280-10-50-7 when concluding that these individuals are not operating segment managers. As part of your response, explain to us if your CEO is separately reviewing the financial results or budgeted to actual variances for your East, West, or Gulf Coast regions in addition to reviewing and discussing the overall NRG Business operations. Additionally, tell us in more detail what specific roles and responsibilities the Regional Presidents have in the meetings with the CODM to review the monthly package and how these differ from the roles and responsibilities of the NRG Business segment manager.

The company's response to the SEC explained that the CEO is responsible for evaluating the performance of segments and allocating resources to the individual segments. The SEC took no action against the company as a result of the query.

A company is well-advised to maintain an organization chart with detailed documentation of the various roles, in particular the segment managers, who are directly accountable to and maintain regular contact with the CODM to discuss operating activities, financial results, forecasts, or plans for the segment. This information aids the preparers and auditors in gaining a better understanding of the responsibilities of related parties in allocating resources and assessing performance, which in turn helps them evaluate a company's segment reporting practices.

Lastly, when a change in the CODM is deemed appropriate, the company should reconsider its segment reporting analysis. For example, changing the CODM from its CEO/COO to a committee, such as in certain instances where these executives delegate their decision-making, will more likely than not result in a change in the conclusions about segment reporting, as delegating operating decisions to the committee often results in changes in the process, and hence information used, for resource allocation and performance evaluation.


Topic 280 defines an operating segment as a component of a public entity that has these three characteristics:

  • It engages in business activities from which it may earn revenues and incur expenses;
  • Its operating results are regularly reviewed by the entity's CODM to allocate resources and assess performance; and
  • Its discrete financial information is available.

Under Topic 280, public entities are required to report separately information regarding each "reportable segment," i.e., an operating segment that constitutes 10% or more of reported revenues, assets, or profit/loss.

Topic 280 employs a management approach to the identification of operating segments. The objective of the management approach is to allow users to see the entity's performance through management's eyes, assess the entity's future cash flows, and make more informed decisions about the entity as a whole. Any discrepancies between the operating segments identified by the company and the level at which discrete financial information is available internally to the CODM indicate that the company's segment reporting may not comply with Topic 280 (see the sidebar "PACCAR's Parts Business: A Separate Segment").

Pursuant to Topic 280, an operating segment is a component of an enterprise, for which discrete financial information is available to the CODM, to assess performance and allocate resources. Discrete financial information must be sufficiently detailed to allow the CODM to make such decisions. Nevertheless, a company shouldn't conclude that discrete financial information is not available simply because certain costs are shared and not allocated specifically to each component. Gross profit information, or other operating measures, provided to the CODM and used to assess performance and allocate resources, could be considered as discrete financial information (see the sidebar "What Is Discrete Financial Information?").

Although it is important to consider the financial information available to and used by the CODM when identifying an entity's operating segments, the CODM reporting package may not be determinative. Other factors to consider include the overall management structure, such as the roles and responsibilities of those who report directly to the CODM and how the CODM interacts with them (i.e., type and regularity of meetings), the basis on which budgets and forecasts are prepared, and the basis on which executive compensation is determined.

Furthermore, public companies should make sure that they are consistent throughout different communication channels when referring to operating segments, as the SEC reviews information from companies' earnings calls, websites, industry publications, press releases, and analyst presentations, in addition to public filings, such as the business section and management's discussion and analysis (MD&A) of Form 10-K. The SEC has asked companies to explain any perceived inconsistencies between the descriptions of the business in their segment footnote and in other public information. The SEC has also requested an explanation about inconsistencies between the segment disclosures in different SEC filings.

For example, the SEC questioned Graphic Packaging Holding Co.'s segment reporting practices, noting that the segment disclosure in its third quarter 2015 Form 10-Q differed from the segment disclosure in its 2015 Form 10-K. The company explained that a change in CEOs led to a restructuring of internal reporting and that as a result, the results were appropriately disclosed. The SEC took no further action. As another example, the SEC comment letter to Community Health Systems Inc. dated July 21, 2016 (File No. 001-15925) states:

We note you have identified two operating segments. In your Q1 2016 earnings call presentation, you present five hospital divisions led by five division presidents. Please tell us how you determined the five hospital divisions do not represent operating segments under FASB ASC [Paragraph] 280-10-50-1. In your response, please ... identify and describe the role of each of your division presidents ... Tell us how often the CODM meets with his/her direct reports, the financial information the CODM reviews to prepare for those meetings, the financial information discussed in those meetings and who else attends those meetings ... Explain how budgets are prepared, who approves the budget at each step of the process, the level of detail discussed at each step, and the level at which the CODM makes changes to the budget ... Describe the level of detail communicated to the CODM when actual results differ from budgets and who is involved in meetings with the CODM to discuss budget-to-actual variances ... Describe the basis for determining the compensation of the individuals that report to the CODM.

The company provided the information and reaffirmed to the SEC its conclusion that each individual hospital did not meet the definition of an operating segment. The SEC took no action.


As outlined in Topic 280, two or more operating segments may be aggregated for reporting purposes even though they may be individually material, if aggregation is consistent with the objectives and basic principles of Topic 280, if they exhibit similar economic characteristics, and if the segments are similar in each of the following areas:

  • The nature of the products and services;
  • The nature of the production processes;
  • The type or class of customer for their products and services;
  • The distribution methods for their products or services; and
  • If applicable, the nature of the regulatory environment in which they operate.

Under Topic 280, the guidance on the appropriate level of aggregation of information for segment disclosures is not prescriptive and permits judgment. Therefore, the regulators evaluate a company's disclosure practices on a case-by-case basis. It is presumed that users of financial statements would prefer disaggregated information and that operating segments should be aggregated only if providing more detailed information would not further aid a user in understanding the entity. Consequently, companies should keep proper documentation of the analysis and judgments pertaining to the aggregation of operating segments. For instance, in its comment letter to The Hain Celestial Group dated Jan. 13, 2012, the SEC requested the company to "[i]dentify any operating segments which have been aggregated in the amounts disclosed for your reportable segments. And for all operating segments which have been aggregated, submit the analysis that you performed in concluding that aggregation is appropriate." The company eventually changed its previous one-segment configuration to reflect four geographic operating segments, which resulted in three reportable segments (US, UK, and Other, comprising Canada and Europe).

Furthermore, the judgments needed in the aggregation of operating segments should be based on a thorough understanding of an entity's specific facts and circumstances. For instance, testing for "similarity" calls for careful evaluation of the company's product lines. In particular, the SEC put a clear emphasis on the objectives and principles of the standards in evaluating similarity of operating segments, and reminded the companies and auditors to consider information such as industry reports and other analysis to better understand how a reasonable investor would analyze the company.

Also, companies should maintain documentation of the historical and management forecast of long-term financial performance data pertaining to identified operating segments to ensure that aggregated operating segments have similar long-term financial performance. The financial performance data often include net sales, gross profit margin, operating income, and other profit measures.

Additionally, the SEC requires that companies and auditors continually monitor any changes in circumstances that may affect the identification or aggregation of operating segments. Examples of changes that may prompt the SEC staff to seek additional information about registrants' reportable segments include a change in organizational structure, key personnel changes, or significant acquisitions and dispositions.


The guidance on segment reporting outlined in Topic 280 requires the application of reasonable management judgment. Effective internal control over financial reporting supports those judgments, including the judgments needed in the identification and aggregation of operating segments and the determination of segment disclosures for the entity as a whole. The determination of operating segments can change based on what information the CODM uses to allocate resources and ­assess performance.

Therefore, input from, and the interaction with, the CODM should be a key element in designing effective internal control over segment reporting. The design and operation of management's controls over judgments in segment reporting should be properly documented with a reasonable, detailed description of the basis on which the company deems its practices comply with Topic 280. This documentation will also aid the auditor in evaluating the effectiveness of these controls and help the SEC fully consider a company's segment reporting conclusions.

PACCAR’s parts business: A separate segment

An SEC investigation involving the parts business of PACCAR, a truck and engine maker, demonstrates the importance of properly identifying operating segments. From 2008 to the third quarter of 2012, PACCAR did not report its parts business as a separate segment in public filings, while its internal documents reviewed by senior executives reported operating results for the parts business separately, according to SEC documents.

The SEC alleged that the deficient controls and procedures at PACCAR caused inconsistencies in its reporting practices and kept investors and regulators from seeing the company through the eyes of management. The company disclosed two units to investors, as it combined its truck and parts results in a single segment.

Meanwhile, PACCAR's strategic planning documents, including forecasts and details on upcoming initiatives, had reported three separate segments—for its truck business, parts business, and financial services group. Consequently, the company paid $225,000 to settle the case with the SEC.

What is discrete financial information?

PowerSecure International Inc., an energy technology provider, became the target of an SEC action because from 2012 to the first quarter of 2014 the company disclosed one reportable segment when it should have identified and reported multiple segments. According to the SEC, PowerSecure misapplied FASB Accounting Standards Codification Topic 280, Segment Reporting, in claiming the "discrete financial information" criterion was not met since certain operating expenses were not allocated among its business units with precision below gross profit. However, the SEC stated that to meet this criterion, a business component need only have a measure of profit or loss available—and gross profit is sufficient for this purpose.

The SEC further pointed out that the CEO, who was PowerSecure's chief operating decision-maker (CODM), regularly met with each business unit leader to discuss operational issues, sales forecasts, and financial performance, and that some of the business unit leaders had business-unit-level budgets and forecasts and received incentive compensation based, in part, on the results of their business unit. Therefore, PowerSecure incorrectly concluded that its CODM did not regularly review operating results below the consolidated level and that it only had one operating segment.

Failure to properly identify its operating segments contributed to PowerSecure's incorrect testing for goodwill impairment, as each operating segment should have been deemed a reporting unit to carry out that test. Goodwill impairment was allegedly tested at a higher level than required by Topic 350, Intangibles—Goodwill and Other, "which could have resulted in PowerSecure's failure to recognize a goodwill impairment loss," according to the SEC.

About the authors

Xiaowen Jiang ( is an associate professor of accounting at Western Connecticut State University in Danbury, Conn. Ling Lin ( is an associate professor of accounting at UMass Dartmouth in Dartmouth, Mass.

To comment on this article or to suggest an idea for another article, contact Ken Tysiac, editorial director, at or 919-402-2112.

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