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Disaggregated information: time to reconsider.

Requiring more stringent disclosures may be a step toward harmonization of accounting standards.

Globalization of enterprises, mergers, acquisitions and deregulation all have brought about changes in the way business is conducted and in the ways CPAs report on business activities. Given myriad changes in the business environment and in financial reporting requirements, it is time to reconsider how disaggregated disclosures are made.

Such diclosures are intended to give investors, creditors and other financial statement users a more detailed understanding of an enterprise's diverse operations. They aid users in identifying the factors underlying an enterprise's past financial results needed to assess risk and forecast future returns. Indeed, the Association of Investment Management and Research (AIMR), in its position paper Financial Reporting in the 1990s and Beyond, characterizes disaggregated financial data as indispensable and integral to the investment analysis process.

Financial statement users have exerted pressure on accounting standard setters to issue more stringent requirements for presenting disaggregated disclosures. Current standards require two primary bases for disaggregating consolidated financial data--industry segments and geographic areas--and two other bases--major customers and export sales. Considerable latitude is allowed in determining industry segments and geographic areas. The lack of specific guidance has resulted in inconsistencies in how enterprises define industry segments and geographic areas and in how they identify foreign operations.

In May 1993, the Financial Accounting Standards Board and the Canadian Institute of Chartered Accountants (CICA) accounting standards board (AcSB) jointly issued an invitation to comment, Reporting Disaggregated Information by Business Enterprises, in response. Disaggregated disclosures are one of the challenges standard setters face in their efforts to harmonize international accounting standards. The FASB and AcSB plan to issue an exposure draft in the second quarter of 1995.

This article examines the problems of disaggregated information reporting requirements as identified by the FASB, AcSB and statement users. Changes in the business environment that have necessitated reconsideration of current standards are addressed. Problems with specific aspects of disaggregated disclosures, such as industry and geographic segments, are discussed, as are proposed solutions.


The FASB began requiring disclosure of disaggregated information with the issuance of Statement no. 14, Financial Reporting for Segments of a Business Enterprise,, in 1976. The CICA began requiring such disclosures in 1979. Both standards require disclosure of information about an enterprise's industry and geographic segments as well as export sales and major customers.

Both the FASB and AcSB do not allow the practice of excluding from consolidation those subsidiaries whose operations are not homogeneous with their parent's, raising concern on the part of some users that important information about parent companies primary operations is not being reported adequately. Many statement users say current standards fail to consider the effects of mergers and acquisitions, the globalization of enterprises and the deregulation of certain industries, which has permitted participants to diversify into nonregulated business activities. The invitation to comment represents the first step by the FASB and AcSB in addressing these concerns.


Critics of U.S. and Canadian standards decry the lack of specific guidelines in determining industry segments. They say current guidance allows too much latitude, resulting in groups of products and services that are too broad to be meaningful. Some argue managers have taken advantage of the situation to suit their own financial reporting purposes.

FASB and AcSB discussions with analysts and company representatives as part of the disaggregated disclosures project concluded industry segments should be determined based on the way an enterprise is managed. Both bodies said such an approach would allow users to base their evaluations of an enterprise on essentially the same information used internally management, reducing costs and resulting in more reliable information.

Provisions exempting enterprises from disaggregating in certain circumstances (such as when an enterprise operates predominantly in a single industry segment) or from disaggregating vertically integrated and foreign operations also may need to be revised and expanded to ensure more complete information is provided. For example, analysts have recommended revenues and operating profits should be disclosed by product and service line, despite the fact an enterprise might be deemed to be operating in a single industry.


Critics want more specific guidance on how to differentiate between foreign and domestic operations, particularly in light of the increasing number of multinational enterprises and diversity in the structure of international activities. More specific approaches to grouping include geographic segmentation based on the way an enterprise is managed or on a country-by-country basis.

For example, if goods are manufactured in Spain by a wholly owned Spanish subsidiary of a U.S. company and sold to customers in Russia, under Statement no. 14 that activity may be classified either as Spanish or Russian foreign operations. For management purposes, the U.S. parent company may classify the operations as Spanish: The risks and returns may be unique to Spain and have little to do with conditions in Russia.

Statement no. 14 permits attribution of revenues, expenses and identifiable assets to geographic segments based on several criteria, including the locations of accounting records, assets, customers and risks associated with assets and liabilities. Canadian standards do not address attribution. Statement users have suggested increased comparability might be achieved by specifying a single basis (such as country by country) for attributing revenues, expenses and identifiable assets to geographic areas. An alternative approach may be to encourage enterprises to segment revenues based on the location of foreign operations and also on the location of customers, if the two are materially different. The United Kingdom requires disclosures based on both location of operations and location of customers.

As with industry segments, some users are concerned about current significance tests for identifying and reporting on geographic segments. U.S. and Canadian standards apply a 10% significance test to external revenues and identifiable assets after foreign operations have been grouped into geographic segments. Analysts have consistently recommended disaggregation into a greater number of segments. Lowering the threshold below 10% would result in the reporting of more segments and the availability of more information about an enterprise. Analysts and other financial statement users recommend enterprises with no individually reportable geographic segments be required to disclose some minimum information about foreign operations.

The FASB and AcSB recognize that additional financial information relating to industry and geographic segments not required by current standards may be useful to analysts and other statement users. Exhibit 1, page 67, lists items identified during FASB and AcSB research conducted before the invitation to comment was issued.


Potential financial disclosures useful in assessing risks and returns

Analysts and others identified the following financial information as useful in assessing an enterprise's risk and prospective returns.

Industry and geographic segment information

* Identifiable liabilities

* Identifiable net assets (identifiable assets minus identifiable liabilities)

* Categories of identifiable assets, such as rate disclosures of current and noncurrent assets or of inventory; net property, plant and equipment; and goodwill

* Working capital

* Cash flow information

* Research and development expenditures

* Cost of goods sold

* Gross margin

* Interest expense

* A measure of earnings other than operating profit or loss (after adding or deducting one or more of the following from operating profit or loss):

1 .General corporate expenses

2. Interest expense

3. Domestic and foreign income taxes

4. Equity in income or loss from joint ventures and other unconsolidated investees

5. Gain or loss on discontinued operations

6. Extraordinary items

7. Minority interest

8. Cumulative effect of a change in accounting principles

* Restructuring charges

* Per-share segment data

* Number of employees

* Employee salaries, wages and benefits

* Order backlog

Geographic segment information

(Note: The following items already are required for industry segment disclosures and are included only as potential additional disclosures by geographic segment.

* Depreciation expense

* Capital expenditures

* Equity in net income of, and investment in, investees accounted for by the equity method

* Cumulative effect of changes in accounting principles

Source: Appendix F, Financial Accounting Standards Board Invitation to Comment, Reporting Disaggregated Information by Business Enterprises.


U.S. and Canadian standards require disclosure of significant export sales and recommend some breakdown by geographic area for both revenues and operating profit. Statement users express concern that for multinational enterprises, the home country is diminishing in importance as the sole basis for reporting export sales. Export sales from other geographic segments are equally important, particularly when an enterprise relies on a single foreign manufacturing site to satisfy worldwide demand for a product. Disclosure might be necessary for export sales shipped outside the geographic segment.


U.S. and Canadian standards do not require inclusion of segment information in interim financial reports. FASB research, however, found that analysts viewed the addition of an interim reporting requirement for disaggregated information as the single most important change that should be made to current standards. In the AIMR study, analysts cited quarterly reports as vital to assessing an enterprise's financial and operating condition in today's volatile business environment. Analysts recommended that, at a minimum enterprises disclose revenues, operating profits or losses and identifiable assets for each industry and geographic segment on a quarterly basis.


The primary focus of U.S. and Canadian standards is on disclosure of quantitative financial information. Disclosure of the types of products and services from which the revenue for each reportable industry segment is derived is the only descriptive information currently required. Additional information about the nature of the business environment also may be necessary to help analysts better assess the risk and return prospects of the enterprise's business operations. Exhibit 2, page 70, lists descriptive or explanatory information frequently cited by analysts and others as useful in making those assessments.


Nonfinancial disclosures useful in assessing risks and returns

Analysts and others frequently suggested the following descriptive information was useful or essential in assessing an enterprise's risk and prospective returns.

* Description of the industry in which the segment operates

1. Definition of the industry

2. Economic, social, demographic, technological, political and regulatory trends that affect the industry

3. Economic structure of the industry (ability of new companies to enter it; risks of substitute products and services; resource availability, including supplier dominance; customer dominance and competitiveness)

4. Economic outlook for the industry

* Narrative description of the segment's business

1. Principal products and services (now required by Financial Accounting Standards Board Statement no. 14, Financial Reporting for Segments of a Business Enterprise, and the Canadian Institute of Chartered Accountants Handbook)

2. Principal market for these products and services and size of market

3. Process used to make the products or provide the services

4. Key inputs to the process

5. Distribution methods for products and services

6. Seasonality and cyclicality

7. Regulation and legislation affecting the segment

8. Importance of patents, trademarks, licenses, franchises and concessions held

* Statement of the segment's mission

* Segment's strategy and alignment of that strategy with external trends and employee incentives

* Segment's position within the industry

1. Market share and trends in market share

2. Competitors (number, names, resources; relative profitability and other strengths and weaknesses)

3. Relative competitive advantages and disadvantages of the segment (identity, source and sustainability)

* Segment's ability to innovate, adapt to change and continuously improve

1. Enabling infrastructure (organizational structure, business strategy, management philosophy and employee incentives)

2. Recent process, product or service innovations (sources and consequences)

3. Recent changes in the environment and the nature and timing of the segment's response

4. Rate of change in the segment's performance (key operating and financial measures, trend n rate of change and reason for that change)

* Opportunities and risks managed at the segment level

* Quantified nonfinancial op rating data

* Identity of key trends and relationships among the various financial and nonfinancial data reported for the segment and reasons why those relationships may differ from those of competitors, the industry or the economy

Source: Appendix G, Financial Accounting Standards Board Invitation to Comment, Reporting Disaggregated Information by Business Enterprises.


Nonpublic enterprises (but not small enterprises) in both the United States and Canada are exempt from reporting disaggregated information' Critics say nonpublic enterprises should be required to disclose disaggregated information. Disaggregated disclosure requirements in the United Kingdom apply to economically significant nonpublic enterprises. Exemptions for nonpublic enterprises ignore the fact many of them are large and complex, their financial reports are widely distributed and they may be in direct competition with entities whose securities are publicly traded.

Some advocate that small enterprises either be exempt from or be subject to different disclosure requirements than larger enterprises because the relative costs of providing segment information are much higher for small enterprises. Risk of competitive harm resulting from such disclosures may be greater for small firms.

Others argue that all enterprises should be allowed to omit disaggregated information management deems competitively harmful because it may provide valuable information to competitors. Many nonpublic and foreign enterprises are not subject to the same reporting requirements, leaving those that are at a competitive disadvantage. The United Kingdom, France and the Netherlands, among others, allow enterprises to omit information that would harm them competitively but require disclosure of the omission.


The invitation to comment marked the first time the FASB developed and issued a comment document jointly with a standard-setting body in another country. The attempt to address internationalization of accounting standards more actively is commendable. Nevertheless, the diversity of practices among countries represents a formidable challenge.

As technological advances lower the costs of additional disclosure requirements, there still is a need for information that will reduce uncertainty and facilitate efficient resource allocation decisions. Disaggregated disclosures are an important component of that information. Modification of the reporting requirements for disaggregated information raises several issues the FASB and AcSB must address; failure to do so could impede both domestic and international financial markets.

* Are analysts' requests realistic in light of the costs of implementing them?

* Will more specific guidelines for disaggregated information exacerbate the standards overload problem?

* Will the joint U.S.-Canadian effort at modifying requirements for disaggregated information cause other nations to harmonize international financial reporting standards?


* RECENT CHANGES IN THE business environment and financial reporting requirements suggest that current requirements for reporting disaggregated information should be reconsidered.

* AN INVITATION TO COMMENT issued jointly by the Financial Accounting Standards Board and the Canadian Institute of Chartered Accountants is not only a reconsideration of the reporting of disaggregated information but also an attempt to harmonize international accounting standards.

* MANY OF THE GUIDELINES FOR reporting disaggregated information in both U.S. and Canadian standards need to be more specific and should be established as requirements rather than as suggestions.

* MORE DESCRIPTIVE AS WELL AS quantitative information should be included in disclosures of disaggregated information.

* EXEMPTIONS FROM DISCLOSING disaggregated information should be eliminated and more nonpublic and small businesses should provide such information.

LARRY A. DEPPE, CPA, PhD, CMA, is assistant professor of accounting, Westminster College of Salt Lake City, Salt Lake City. He is a member of the American Institute of CPAs, the Utah Association of CPAs and the Institute of Management Accountants.
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Author:Deppe, Larry A.
Publication:Journal of Accountancy
Date:Dec 1, 1994
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