Improving internal control over segment reporting

Written by promotiondept

November 13, 2018

Improving internal control over segment reporting 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. […]

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Improving internal control over segt reporting

On Nov. 7, 2016, the SEC instituted and settled a ceaseanddesist order against PowerSecure International Inc., alleging it failed to identify and report its segts as required by FASB Accounting Standards Codification (ASC) Topic 280, Segt 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 segt reporting in prior , which contributed to faulty segt reporting—from 2012 to the ft quarter of 2014, PowerSecure disclosed one reportable segt, when it should have identified and reported multiple segts.

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

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

According to Topic 280, the CODM refers to a specific function within the company that allocates resources to and assesses performance of the segts of a public entity, rather than a manager with a specific title. Identifying the CODM is a critical aspect of segt reporting, as thenSEC 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 decisionmaking authority. Furthermore, the distinction between any strategic and operating decisions is important as the latter pertains to the entity’s daytoday operational decisions. The identified CODM evaluates the entity’s operating results to assess performance and to allocate resources. For instance, in its comt letter to NRG Inc., dated Aug. 20, 2015 (File No. 00115891), 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 segt manager. Please tell us in more detail how you considered the guidance in ASC [Paragraph] 28010507 when concluding that these individuals are not operating segt 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 segt manager.

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

A company is welladvised to maintain an organization chart with detailed docutation of the various roles, in particular the segt managers, who are directly accountable to and maintain regular contact with the CODM to discuss operating activities, financial results, forecasts, or plans for the segt. This information aids the arers 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 segt reporting practices.

Lastly, when a change in the CODM is deemed appropriate, the company should reconsider its segt reporting analysis. For example, changing the CODM from its CEO/COO to a committee, such as in certain instances where these executives delegate their decisionmaking, will more likely than not result in a change in the conclusions about segt 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 segt as a component of a public entity that has these three characteristics:

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

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

Pursuant to Topic 280, an operating segt 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 segts, the CODM reporting package may not be determinative. Other factors to consider include the overall managet 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 ared, and the basis on which executive compensation is determined.

10K. The SEC has asked companies to explain any perceived inconsistencies between the descriptions of the business in their segt footnote and in other public information. The SEC has also requested an explanation about inconsistencies between the segt disclosures in different SEC filings.

For example, the SEC questioned Graphic Packaging Holding Co.’s segt reporting practices, noting that the segt disclosure in its third quarter 2015 Form 10Q differed from the segt disclosure in its 2015 Form 10K. 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 comt letter to Community Health Systems Inc. dated July 21, 2016 (File No. 00115925) states:

We note you have identified two operating segts. 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 segts under FASB ASC [Paragraph] 28010501. 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 are for those meetings, the financial information discussed in those meetings and who else attends those meetings … Explain how budgets are ared, 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 budgettoactual 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 segt. The SEC took no action.

As outlined in Topic 280, two or more operating segts 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 segts are similar in each of the following areas:

Under Topic 280, the guidance on the appropriate level of aggregation of information for segt disclosures is not prescriptive and permits judgt. Therefore, the regulrs evaluate a company’s disclosure practices on a casebycase basis. It is presumed that users of financial statets would prefer disaggregated information and that operating segts should be aggregated only if providing more detailed information would not further aid a user in understanding the entity. Consequently, companies should keep proper docutation of the analysis and judgts pertaining to the aggregation of operating segts. For instance, in its comt letter to The Hain Celestial Group dated Jan. 13, 2012, the SEC requested the company to “[i]dentify any operating segts which have been aggregated in the amounts disclosed for your reportable segts. And for all operating segts which have been aggregated, submit the analysis that you performed in concluding that aggregation is appropriate.” The company eventually changed its previous onesegt configuration to reflect four geographic operating segts, which resulted in three reportable segts (US, UK, and Other, comprising Canada and Europe).

Furthermore, the judgts needed in the aggregation of operating segts should be based on a thorough understanding of an entity’s specific facts and circumstances. For instance, testing for “similarity” calls for eful 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 segts, 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 docutation of the historical and managet forecast of longterm financial performance data pertaining to identified operating segts to ensure that aggregated operating segts have similar longterm 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 segts. Examples of changes that may prompt the SEC staff to seek additional information about registrants’ reportable segts include a change in organizational structure, key personnel changes, or significant acquisitions and dispositions.

The guidance on segt reporting outlined in Topic 280 requires the application of reasonable managet judgt. Effective internal control over financial reporting supports those judgts, including the judgts needed in the identification and aggregation of operating segts and the determination of segt disclosures for the entity as a whole. The determination of operating segts 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 elet in designing effective internal control over segt reporting. The design and operation of managet’s controls over judgts in segt reporting should be properly docuted with a reasonable, detailed description of the basis on which the company deems its practices comply with Topic 280. This docutation will also aid the auditor in evaluating the effectiveness of these controls and help the SEC fully consider a company’s segt reporting conclusions.

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

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

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

PowerSecure International Inc., an technology provider, became the target of an SEC action because from 2012 to the ft quarter of 2014 the company disclosed one reportable segt when it should have identified and reported multiple segts. According to the SEC, PowerSecure misapplied FASB Accounting Standards Codification Topic 280, Segt 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 segt.

Failure to properly identify its operating segts contributed to PowerSecure’s incorrect testing for goodwill impairt, as each operating segt should have been deemed a reporting unit to ry out that test. Goodwill impairt 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 impairt 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 comt 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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