When the Financial Accounting Standards Board (FASB) adopted new rules for reporting the results of business segments last June, a snicker could be heard in finance departments from New York to L.A.
In theory, Financial Accounting Standard (FAS) 131 granted financial analysts their long-cherished objective of an insider view of segment results. Since 1976, when the original segment standard–FAS 14–was approved, companies have reported segment information by broad industry segments and geographic region. That requirement never satisfied analysts and investors. Dissimilar businesses were still lumped together, often out of alignment with management’s discussion of operating units and business plans, and the information was reported only once a year.
Now FASB will require segment information to be reported the same way in annual and quarterly financial statements as it is to the chief operating decision maker, starting with annual reports for fiscal 1998. At a minimum, revenues, operating profits or losses, and assets will have to be disclosed by segment, as will interest expense, depreciation, and equity method investments if segmented internally.
But in practice, the rule will likely make new segment information even more confusing than the old information, to the great pleasure of many a crafty corporate controller. In an earlier version of the proposal, FASB required business units to have the same characteristics in order to be counted together. This limit on segment aggregation would have caused many companies to report more segments than under the current criteria, which allows “similar” segments to be disclosed together. Plus, the exposure draft required more detail by segment, including research-and-development spending, liabilities, customer information, and geographic information by segment.
But that kind of disclosure caused many a boardroom tantrum, especially among members of the National Association of Manufacturers, who complained that it would give sensitive information to competitors and customers, and would subject operating decisions by management to excessive scrutiny by analysts and investors. In the face of such protests, FASB backed down and, in the view of analysts, may even have taken a step backward.
For starters, FASB let companies off the hook by not holding segment disclosures to the rigors of generally accepted accounting principles (GAAP), as they were under FAS 14, so anything that goes internally can now go into segment disclosures. And while international results must now be broken out by country instead of region, only those countries considered “material” need be segmented, allowing the rest to fall into a general international category. And profits no longer need be reported geographically at all.
The outcome has stunned many analysts. “I’m very surprised at this standard,” says Pat McConnell, senior managing director and director of accounting analysis at Bear, Stearns & Co. and chairwoman of the International Accounting Standards Board’s steering committee on segment reporting. “When we at the AIMR [Association of Investment Management & Research] suggested the management approach the first time, in our report Financial Reporting in the 1990s and Beyond, never did we imagine that FASB would introduce a standard that didn’t follow GAAP definitions for all the segment disclosures.” McConnell adds: “It doesn’t fit with a board that has been so meticulous in telling companies exactly what they must disclose and how.”
This lack of uniformity will make it tough to decipher results within companies, let alone compare them with similar segments at other companies. “Comparability was never something we had much of in the past, but now there is even less,” says Jack Cieselski, a Baltimore-based investment adviser and editor of The Analyst’s Accounting Observer.
The Inside Game,br> Whether analysts’ fears are justified greatly depends on the spirit in which companies implement the rule. To that end, controllers and their accounting teams need to reevaluate their current reporting and determine how sensitive external reporting of that information would be.
The first task is to analyze the segments currently reported to the top decision makers and determine which, if any, can be aggregated. At Sears, Roebuck & Co., in Hoffman Estates, Michigan, for example, “we have 20 operating businesses, some of which report to the chief operating decision maker,” says James Blanda, vice president and corporate controller at the $40 billion (in revenues) retailer. “That seemed like too many, as the rule suggests a maximum of 10 segments.” But by applying the aggregation rules, “our current, but not final, analysis shows we would have between 4 and 7 reportable segments.”
The question of exactly how many remains open because FAS 131 allows companies to lump together segments that are roughly equal in profitability and similar in terms of products and services, production processes, customers, distribution, and regulatory environment. That will likely allow Sears to report its department stores and other retail businesses as a single segment, though the business is reported internally in several operating segments. The rule may also allow Sears to consolidate those full-line stores with its home stores and auto stores into one “retail” segment, says Blanda.
Three other businesses will also likely stand alone: the credit operation, which has provided a sizable piece of Sears’s overall profits in past years; the home services business, which provides appliance repair and home improvements; and the international segment. Finally, Sears would report a “corporate” segment, as will most companies.
Smaller operating segments, like Sears’s direct-marketing group, would not likely meet the standard’s minimum quantitative threshold of 10 percent of revenues, profits, or assets. As a result, these businesses will likely be folded into the substantially similar services group, explains Blanda.
While not an issue for Sears, there is also a minimum segmentation standard that requires results for businesses representing at least 75 percent of total revenues to be reported by individual segments. At some highly segmented companies, that would mean that results for smaller segments that do not meet the quantitative thresholds must be reported.
All of this raises the question of whether companies will change their management structures to get around elements of the rule that they dislike. For instance, a company might require the head of a smaller segment to report not to the chief decision maker but to another executive, avoiding any need to disclose that unit’s results to the public. “I’ve heard innuendo already that some companies may make some internal reporting changes to get the segment groupings they want, mostly to reduce competitive harm,” says James Harrington, director of accounting and SEC technical services at Coopers & Lybrand LLP.
Separately, many companies may decide to alter the internal cost allocation methods or formulas they use for tracking segments, particularly those that don’t follow GAAP. “We’re already considering some changes to our internal reporting,” says Bill Lowe, controller of Columbus, Indiana-based Arvin Industries Inc., a $2.4 billion (in revenues) maker of exhaust and suspension systems for the auto industry. “I suspect many companies may do that. No one wants big reconciliations to explain the gap between segment numbers and overall results.”
Examples of potentially large reconciliation items include future retiree benefit costs; goodwill from purchase method transactions; and shared services costs, for operations like accounts payable processing or purchasing if done centrally.
“Unless you charge some of this stuff back to the units, your segment information is going to get really messy,” says Lowe.
The Outside Game
All this internal rejiggering is needed because most finance executives hope to report the absolute minimum to satisfy their external auditors and the Securities and Exchange Commission that they are complying with the new rule. The main reason, they say, is to reduce the amount of information that would be useful to competitors, vendors, and customers.
“Any additional information we have to report on our business units would be useful to Caterpillar or John Deere,” says Bob Naglieri, vice president and controller of $5.5 billion (in sales) Case Corp., an agricultural- and construction-products maker in Racine, Wisconsin. “Of course, anything we can get on them would be useful, too. So I think everyone is going to try to put forward as little information as possible.”
There is also the fear that customers and vendors will respond to new disclosures of wide-margin businesses with tougher bargaining.
“I think I’ll be able to learn a lot about some of my vendors and manufacturers, and I’ll naturally be using that information when we sit down to negotiate with them,” says Don Platt, CFO of US Office Products Co., in Washington, D.C., a $3.5 billion nationwide office-supplies and business-services firm. “Of course, that may be difficult. There are a lot of games one can play with this standard, and everyone will have a different reporting method, so real profitability will be tough to determine.”
But analysts doubt that more information about business segments will hurt a company’s competitive position. “We all heard the same thing when FAS 14 was introduced, but everyone got used to it,” says Bear, Stearns’s McConnell. “After all, most competitors know much more about each other financially than is reported already, so there will be little news in these new disclosures for them.”
To analysts, the complaint is merely a smoke screen for corporate executives who simply want to prevent investors from criticizing their decisions and revaluing businesses based on their parts. But now that FASB has backed down from requiring more-specific disclosures, those executives needn’t prove Wall Street wrong.
Ian Springsteel is an associate editor at CFO.