ASU 2023-07, Segment reporting: PwC

Expanded requirements for segment disclosures

Rarely does a new accounting standard impact virtually every public company, regardless of sector. That is the case with the introduction of ASU 2023-07, Segment Reporting – Improvements to Reportable Segment Disclosures (the “ASU”). The ASU significantly expands the requirements for segment disclosures, which have remained fundamentally unchanged since the current guidance was issued in 1997. The updates are intended to respond to concerns raised by investors about the need for more detailed information at the reportable segment level and follow a theme of disclosure disaggregation called for by investors in recent standards (e.g. ASU 2023-09, Improvements to Income Tax Disclosures and the Disaggregation – Income Statement Expenses project).

The updates prescribed in the ASU are incremental to the existing segments framework. The ASU does not change the overall management approach to segment reporting. In other words, the identification of operating segments, aggregation of operating segments and overall determination of reportable segments is unchanged.

For calendar year-end companies, the ASU is effective for public entities in 2024. For non-calendar year-end companies, the ASU is effective in 2025. The ASU should be adopted retrospectively as of the beginning of the earliest period presented in the financial statements.

Why does the new guidance matter?

Segment information is critically important to investors and other allocators of capital. Segment information helps users of the financial statements better understand an entity’s overall performance and assists with understanding potential future cash flows. Additional information provided in the financial statements through the enhanced segment disclosures will help investors better assess financial trends, perform more precise financial modeling and better evaluate an entity’s business activities. Further, enhancing investors’ understanding of the composition of segment expenses and how they vary over time may be helpful in signaling when significant changes will occur in the reporting entity.

Segment reporting continues to be a frequent area of comment by the SEC staff and we anticipate they will focus on registrants' compliance with the new guidance.

What can companies do to prepare for the new guidance?

Identify significant segment expenses

Management should assess the segment level expense information regularly provided to, or easily computed from information provided to, the Chief Operating Decision Maker (CODM). Availability of data and financial system capabilities will also need to be considered to support the preparation of enhanced disclosures.

The new guidance requires entities to disclose significant segment expenses that are regularly provided to, or easily computed from information provided to the CODM that are included within a reported measure of segment profit or loss during the period of adoption. The guidance does not define the terms “significant,” “regularly provided” or “easily computed.”

When evaluating significant segment expenses, significance should be assessed using both quantitative and qualitative factors relative to the segment’s results, rather than relative to the consolidated financial statements. Significance is not a one-size-fits-all term and should be evaluated on an entity-by-entity basis. As such, management should align their quantitative assessment of the significance of segment expense categories with the entity’s process for determining materiality in other areas of financial reporting.

Existing guidance under Topic 280 emphasizes information which is “regularly reviewed” by the CODM in the identification of operating segments (which is unchanged by the ASU). Information that is “regularly provided” to the CODM is intended to be a more comprehensive criterion than information that is “regularly reviewed” and, in some instances, may result in more information being disclosed than when compared to the previous framework. Reporting entities may consider whether segment expense information regularly provided to the CODM can be considered insignificant. Some factors to consider may include, but are not limited to, the size and importance of the expense item to the segment’s results, the variable and volatility of the expense item and the focus of stakeholders both internally and externally to the organization.

Companies should assess their reporting processes to confirm what segment information is regularly provided to the CODM and whether the emphasis in the ASU on information “regularly provided” results in the identification of additional segment expense information. Information regularly provided to the CODM may include information obtained through access to management information systems.

In recent remarks, the SEC staff noted that in general, quarterly reviews of operating results would typically be considered "regular." However, this does not mean that a frequency less than quarterly would not be considered "regular." Entity-specific facts and circumstances should be assessed in determining what information is “regularly” presented to the CODM.

In the context of the ASU, easily computed amounts may include segment expense information that is expressed in a form other than actual amounts, for example, as a ratio or an expense as a percentage of revenue. Other examples may include:

instances where segment revenue and segment gross margin are regularly provided to the CODM whereby it is concluded that segment cost of sales can be easily computed, and
instances where the CODM regularly receives a segment revenue amount and segment warranty expense expressed as a percentage of segment revenue and a corresponding conclusion that segment warranty expense can be easily computed.

Entities will also be required to disclose an amount and narrative description of total other segment items (expense) not included within the significant expense measures for each reportable segment. The other segment items are reconciled as segment revenue less the segment expenses disclosed as significant, for each reported measure of segment profit or loss as shown in ASC 280-10-55-48, Example 3, Case B.

Determine measure(s) of segment profitability

Reporting entities should determine whether their CODM uses multiple measures of segment profit or loss. Management should align this assessment with existing reporting to investors outside of the financial statements. Measures which are not determined in accordance with GAAP remain subject to existing rules and regulations on non-GAAP measures.

The new guidance clarifies that if a CODM uses more than one measure of profit or loss in assessing segment performance and deciding how to allocate resources (e.g., segment gross margin and segment operating income), a public entity may report one or more of those additional measures of segment profit or loss in its financial statements. Entities have historically been precluded from disclosing more than one measure of segment profit or loss.

While the guidance allows for the disclosure of multiple measures of segment profit or loss, an entity may assess and determine if disclosure of a single measure remains appropriate, such as when the CODM only receives one such metric. If an entity identifies multiple measures of segment profit or loss, it must disclose, at a minimum, the measure that is most consistent with GAAP.

Additional measures of segment profit or loss that are not determined in accordance with GAAP remain subject to the SEC’s non-GAAP requirements in Regulation G and Item 10 (e) of Regulation S-K. This concept was a point of significant discussion at the 2023 AICPA & CIMA Conference on Current SEC and PCAOB Developments. The interplay between the ASU and the existing SEC rules and regulations is likely to remain the focus of regulators in the adoption of the ASU. Reporting entities which utilize multiple measures of segment profit or loss that are not determined in accordance with GAAP may consider discussing their proposed presentation directly with relevant advisors (e.g. auditors, legal counsel, etc.) and the SEC staff. As we expect the practical application of the guidance to evolve over time, registrants should take a holistic view when considering their timing of adoption.

Entities will also now be required to disclose 1) information about the title and position of the CODM and 2) how the CODM uses the reported measure(s) of segment profit or loss in assessing segment performance and deciding how to allocate resources.

Prepare for additional disclosures needed on an interim basis

The ASU introduces significant incremental segment disclosure requirements for interim reporting. Companies should consider whether there will be any operational constraints to aggregating and disclosing this information on a quarterly cadence, including whether current data aggregation processes and systems used in the reporting of significant segment expenses are standardized and under a controlled environment.

The ASU expands the amount and types of disclosures required by reporting entities on an interim basis. Under the ASU, reporting entities will now be required to provide all disclosures about a reportable segment’s profit or loss and assets that are currently required only for annual periods on an interim basis as well. Reporting entities will also need to provide interim disclosures of significant segment expenses and a reconciliation to segment revenues.

Registrants should consider the timing and preparation needs for the data supporting these disclosures, including an ability to run reports tracking such information on a timely basis for quarterly reporting. An evaluation of financial systems, data capabilities and staffing may be needed to properly comply with such requirements upon adoption.

Assess the impact for single segment reporting entities

Single segment entities should assess their previous disclosures against the new disclosure requirements to determine whether incremental disclosures will be required. This evaluation may involve considering whether the reportable segment constitutes all or part of the registrant.

While the existing guidance previously required companies with a single reportable segment to provide entity-wide disclosures such as information about a reporting entity’s products and services, historical practice was mixed. The ASU explicitly requires a public entity that is a single reportable segment to provide all the disclosures required by the amendments in the guidance and all existing segment disclosures in Topic 280. Single segment reporting entities should assess their current reporting and consider the need for additional disclosures.

Reporting entities should evaluate the existing guidance when identifying their operating segment(s) and determine whether that operating segment constitutes all or part of the consolidated entity. There may be instances where management determines that a single operating segment constitutes all of the consolidated entity. Alternately, management may track expenses for their corporate headquarters or certain functional departments separate from the rest of the reporting entity. In these cases, the CODM may review the operating results and performance of the operating segment differently than how management assesses the performance of the consolidated entity.

However, it should be noted that the SEC staff has commented that when a single reportable segment entity is managed on a consolidated basis, there is an expectation that the measure of segment profit or loss that is most consistent with GAAP is consolidated net income.

Other financial and non-financial considerations

Consider the impact on dealmaking

As the ASU will impact every current or potential public company, dealmakers should be mindful of the impact of adoption of the ASU when considering deal structures and the timing of a potential transaction.

The ASU may have a pervasive impact on nearly all public companies, regardless of sector. Dealmakers should be particularly mindful of the impact of the standard on potential transactions. Below are some specific considerations for dealmakers:

Initial public offering and/or Special Purpose Acquisition Company (SPAC) transactions – as private companies are not required to comply with the disclosures in ASC 280, new registrants will also need to be mindful of these additional disclosure requirements. As noted earlier, this is a frequent area of SEC comment which new registrants should focus on to avoid slowing down an offering.
Acquisitions – registrants undertaking an acquisition should consider the impact that the acquisition will have on the way the combined company is managed going forward. Registrants should think proactively about any potential increased disclosures that will be needed (i.e., what is segment structure post-deal and does the data exist).

Divestitures – in a spin-off transaction, audited financial statements of the spinee that are public company compliant are required in the registration statement. These financial statements will need to include segment disclosures and depending on the timing of the filing of the registration statement, may need to comply with the new ASU.
Other capital raising transactions - in connection with many capital markets transactions, a comfort letter from the external auditors is required by underwriters. To the extent underwriters request certain financial information within the prospectus to be “circled” that is outside of the financial statements or other information that is derived from financial systems outside a Sarbanes-Oxley Act of 2022 compliant environment, an auditor may not be able to provide comfort over such information. An inability to provide comfort over such balances could slow down a capital raising process.

Align with other areas of financial reporting and non-finance operating teams

Companies should team with a broad group of internal and external stakeholders to develop consistency with other information presented to investors and establish processes for identifying updates to internal reporting provided to the CODM.

The updates provided in the guidance position a reporting entity’s segment disclosures to better complement other data currently received by investors in public filings outside of the financial statements, including registration statements, earnings releases, management’s discussion and analysis and investor presentations.

It is also important for management outside of the accounting function to understand the ASU’s broad focus on data provided to the CODM. Companies should be particularly mindful of financial and performance information that is provided to the CODM outside of formal periodic reporting, including electronic reporting, and the impact it could have in the application of, and ongoing compliance with, the ASU.

Management should continue to assess communications including, but not limited to, budgets, forecasts, compensation plans, investor communications and access to electronic systems, as there could be meaningful disclosure implications. Management should align this assessment with information presented to market participants, including talking points in earnings calls and other public statements by the CODM and key stakeholders.

To implement the ASU, stakeholders from all functional areas should carefully consider potential reporting requirements through the fiscal year-end in the period of adoption. It is important that a cross-functional team proactively assesses the impact of the guidance on their disclosures to identify potential complexities and constraints to adoption early in their implementation process.

How PwC can help

Our cross-functional team has years of industry expertise and is ready to help you successfully navigate the challenges of new standard implementation. Contact our team member below to talk about how we can work together on your adoption of the ASU.

John Vanosdall

Accounting Advisory Solution Leader, PwC US

Email

We would like to thank Doug Smith, Jackson Udelsman and Conrad Nelson for contributing to this article.

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