3(a). Compliance and Criticisms of Statement 14
Seventy-six percent of the professional investor sample said that annual reports all too often fail to display segment numbers prominently and clearly. (While the SEC requires business segment reporting, companies can emphasize or de-emphasize this information to the extent they wish, including relegating it to a financial footnote near the back of the report.) [HILL KNOWLTON, p. 9-10]
In their comments, professional [investors] . . . said that they are interested in long-range forecasts by segment, and that they feel companies sometimes manipulate segment data to obscure, rather than inform: [Also included in 3(e) and 12] [HILL KNOWLTON, p. 10]
"A line-of-business breakdown should be as meaningful as possible, and very detailed. But sometimes, it appears that a company is deliberately trying to muddy the waters when it mixes apples with oranges and gives so much detail that the numbers become meaningless." (Chicago insurance group analyst) [HILL KNOWLTON, p. 10]
"I want clearer breakdowns by segments and explanations of business performance by segments. The more the better. (Boston insurance group analyst) [HILL KNOWLTON, p. 10]
"Annual reports have poor segment data, and are jumbled and confusing." (Boston mutual fund analyst) [HILL KNOWLTON, p. 10]
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[Investors have observed] that business segment information is often (some said usually) poorly reported. Either important details are omitted, or the business segments reported do not coincide with the way the business is actually conducted. [SRI, p. 56]
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[Context] The following brief summary of the topic "Disaggregated Financial Statements," is from the "Executive Summary" of the report the AIMR's Financial Accounting Policy Committee (FAPC):
Analysis of a complex economic entity requires information about the workings of each of its components. There is no disagreement among financial analysts that segment information is totally vital to their work. There also is general agreement among analysts that the current segment reporting standard, FAS 14, is inadequate. Recent work by a subcommittee of the FAPC has confirmed that a substantial majority of analysts seek and, when it is available, use quarterly segment data. [Also included in 3(b) and 3(c)] [AIMR/FAPC92, p. ix]
The FASB recently initiated a project on disaggregation for which AIMR is providing partial financial support in addition to its overall endorsement. We do not wish to prejudge the results of research now in its initial stage, but we do suggest an avenue for the FASB's researcher to explore. We believe that segment data are most useful when they depict the way in which the enterprise itself is organized and managed and we urge the FASB to seek ways to promulgate a standard that produces such a result, despite the several difficulties in doing so that we acknowledge and discuss in the report. [Also included in 3(b) and 3(c)] [AIMR/FAPC92, p. ix]
[Context] It indicates the scope of the discussion of the topic and lists the report's major recommendations, providing an introduction to the following excerpts from the report.
Financial analysts have consistently over the years requested financial statement data disaggregated to a much greater degree than it is now. Most analysts have found the provisions of 1976's Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise," helpful but inadequate. This situation has been exacerbated by the issuance in 1987 of Statement of Financial Accounting Standards No. 94, "Consolidation of All Majority-Owned Subsidiaries." That statement has the good effect of presenting an overall report on complex economic entities and brings onto the consolidated balance sheet a large amount of debt that previously had not appeared there. Its cost has been the loss of much detailed information about subsidiary operations quite different in character from those of the parent company. [Also included 3(c)] [AIMR/FAPC92, p. 39]
Reporting How the Business is Managed
FAS 14 requires disclosure of line of business information classified by "industry segment." Its definition of "segment" is necessarily imprecise and it recognizes that there are numerous practical problems in applying that definition to different business entities operating under disparate circumstances. That weakness in FAS 14 has been exploited by many enterprises to suit their own financial reporting purposes. As a result, we have seen one of the ten largest firms in the country report all of its operations as being in a single very broadly defined industry segment. At the other extreme, there is a publicly-owned provider of funeral services that reports in three segments: funeral services, caskets and other merchandise sales, and cemetery operations. We also are aware of and sympathetic with the problems some enterprises have in collecting and reporting data that conform to FAS 14 categories because their businesses are organized and managed differently. [Also included in 3(c)] [AIMR/FAPC92, p. 40]
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[Context] Meeting of the Investor Discussion Group on October 16, 1992. During the preliminary discussion on the objectives and approaches of investors and the types of information they use, some investors commented on the deficiencies of the current disclosures of disaggregated information.
Participant I-6
As a fundamental analyst, I try to forecast earnings. In order to forecast earnings, you have to have a basic understanding of what the company is doing and how it does it. That includes an understanding of the product and the market for the product and, basically, when you look at financial reports, the only thing they tell you is a bunch of numbers that are financial related, but it would help if we knew what the quantity was of what the company produces. There is also a lack of compliance with FAS 14 on segment disclosures. So when we try to forecast earnings and we don't know the quantity of products the company produces, it's very hard to really forecast those earnings. [Also included in 1(a) and 13] [TI 10/16, p. 3]
Participant I-7
Within our organization, there are probably 100 analysts. For the most part, we are very industry specific. [Participant I-6] will follow metal companies, I will follow electrical equipment companies, such as [names deleted] and the likes. One of my primary functions is to directly influence the buy, hold, sell investment decision-making policies on companies in my industry. Within that context, if I had to focus on one single element that is extremely crucial, it's earnings. I also agree with [participant I-6], there is a FAS 14 on the books which for the most part is useless. Either the companies are dismissing it or using it to show how they would like to be viewed from an external point of view, but I would like to see a company the way it looks at itself from an internal point of view. Most of the FASB presentations absolutely don't do that. [Also included in 1(a)] [TI 10/16, p. 3]
Participant I-12
Segment reporting is something that is absolutely critical to an analyst. For example, for [a large, diverse financial institution], the cash flows generated by the credit card business have entirely different sources and uses than the cash flows generated by the securities business. It's very difficult from what we see to find that out and find a base from which we can forecast. [Also included in 1(a) and 3(b)] [TI 10/16, p. 4]
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Participant I-7
I head a subcomittee that looks at investor information in the electrical equipment industry. The disseminated information is very uneven. A major effort was made over the last 5 years to get some consistency in FAS 14 reporting; probably 75% of my companies do not report sufficiently on a FAS 14 basis. The other point that is absolutely critical is giving out meaningful industry information. In the more mature industries, you can get government statistics, but in a lot of cases, those statistics are 12 to 24 months old in time. If I can get some consistency in reporting in the annual report on industry information, that is, total statistics, growth by segments, and market share, the truthfulness of that information can be checked by playing one company off against another. That information is very critical. [Also included in 1(b) and 13] [TI 10/16, p. 20-21]
Participant I-12
I head a subcommittee for the AIMR reporting on financial services. What I find interesting going through that exercise every year is that, if you have a diversified financial company like [names deleted], those companies do not report segment data that is comparable to the rest of that particular industry. It has started to get better but the companies are concerned with the cost of preparing that data. But yet, you know they already have the data, they just don't want to publish it. It's really important that when they publish segment data that it bears some resemblance to the industry data in which that segment is competing. [Also included in 3(b)] [TI 10/16, p. 21]
Participant I-7
We don't get good FAS 14 disclosure in the annual report and we get less from most of our companies in the quarterly reports. FAS 14 is just an abomination at least in my industry from a quarterly point of view. I also heard the argument about the expense of creating this information. There isn't a reasonable size company that doesn't have internal reporting and the people inside the company get a report card, if not monthly certainly quarterly, and that's the kind of information that is readily available that I would like to see. One of the things that should be discussed somewhere is: what the information that we as outside investors should not be permitted to get from a competitive point of view? They all know internally what their competitors are doing and yet they don't want to provide certain information to us for competitive reasons. It's vital that the accounting profession decide what kinds of information are competitively harmful and others that aren't. [Also included in 1(b), 2(d), 3(b), 3(d), and 11(c)] [TI 10/16, p. 21]
Participant I-11
I join the chorus on segment accounting. We could do with much more consistent and detailed segment accounting on a quarterly basis. At least two diversified companies that I know establish the segments they report in a manner totally separate from the method in which they run their business and it's clear they're just trying to obfuscate things. I can't find any justification for that. [Also included in 1(b), 3(c), and 3(d)] [TI 10/16, p. 22]
Participant I-8
I follow companies that are in technology areas and they almost all assess they are in one industry. They don't give even a lousy segment reporting, they don't give you any. I met somebody who worked for [name deleted] 4 or 5 years ago who commented that at one point in time, they made 300% of their profit in 3 factories that produce mainframes and every one of the other (I don't know if they had 50 or 100 factories) all lost money. I would wager that in none of the [name deleted] reports did anything like that was ever disclosed. All the financial reporting didn't give anybody an idea of how vulnerable even [name deleted] was to something happening to their mainframe business. [TI 10/16, p. 22]
Participant I-1
But if you end up with every company saying they're making 80% of their money with 20% of their products, it would become as meaningless as the MD&A. [TI 10/16, p. 22]
Participant I-8
There's a lot of companies that don't even try, but there are a lot of differences between companies that say they're in one business. [TI 10/16, p. 23]
Participant I-3
I agree that segment reporting is not as good as it should be and should be improved. But a lot of companies will resist that for a variety of reasons, and in some cases it is because they themselves don't know what is critical to their own businesses. The analyst's job is to find out what is critical. Disclosure will always be somewhat disatisfying because it will never be full. When a company is witholding information from me, there are plenty of other entities that I can focus on; I don't need to have a strong opinion on all of them. I just need to have an accurate opinion about a few of them. [Also included in 1(b)] [TI 10/16, p. 24]
Participant I-8
Part of this will be the result of the pressure that the AICPA can bring on management to make more disclosures. The most common argument for limiting segment disclosures is the fear of competitive disadvantage. A company that I have been following for a long time in Long Island and that has a sensational record of growth have been providing for a long time very detailed market share information, including what they thought their competitors' shares are, and it hasn't been a disadvantage to them. I would argue that additional disclosure doesn't hurt. [Also included in 1(b) and 13] [TI 10/16, p. 25-26]
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Participant I-6
I really appreciate the interest of the accounting community to sollicit us on what additional information we want but there is a number of us in this room that would really like to see the more rigorous enforcement of existing disclosures that are already required. It would be a lot more helpful to us if FAS 14 disclosures were implemented across the board. [TI 10/16, p. 57]
[Context] Meeting of the Investor Discussion Group on December 9, 1992. The first part of the meeting was devoted to the topic of disaggregated information.
Committee/Staff/Observer
At our first meeting, most of you mentioned that the aspect of financial reporting most in need of improvement is segment reporting. Our first 7 questions relate to that topic. Some of you told us that part of the problem with segment reporting is that some companies do not comply with either the letter or the spirit of the current reporting requirements contained in FASB 14. We are interested in knowing whether you agree with that complaint. And for those of you who agree, please help us understand in which ways the companies fail to comply with the rules. [TI 12/9, p. 2]
Participant I-7
I brought some materials along. I will give you two examples, one on [one company] and the other on [another company]. First, there is a three-page summary headed [latter company name]. In the annual report, what you will see is a breakdown between consumer, commercial and industrial, government and defense, and occasionally an eliminations account. This is close to an $8 billion company. On the next page, what you will see is some 34 years of following the company, trying to keep track of well over 100 acquisitions. If you look at the different groups, particularly commercial and industrial, you will see a group that does some $6 billion in volume and with 15-20 units that will range in size anywhere from $60 million up to close to $1 billion. Aside from the difference in terms of volume within the group, there is a wide disparity in terms of product and market. For example, for [name deleted], which is close to a $1 billion entity, over 50% of its business is done outside the US and it is a leader in the process control business. That is one example of what one has to deal with in terms of FASB 14 where the only information one gets is once a year in a very aggregated format (as shown on the first page). [TI 12/9, p. 2]
The other example in the materials is a FASB 14 attempt at a breakout by [name deleted]. If you look at 1991, there is a group category called industries. (This is another company that doesn't report breakouts on a quarterly basis.) Housed within this business is a wholesale electrical distributor called [name deleted] that does something approaching $1.7 billion. If one had not followed the company for a long period of time and made a lot of field visits, it turns out that over 50% of the volume in this business is done by that enterprise and that enterprise, in a good year, does 2.5% in terms of operating profit. [TI 12/9, p. 2-3]
Participant I-4
[Participant I-7], on the [name deleted] report, the estimates on the second and third pages are your work, not [name deleted's]. [TI 12/9, p. 3]
Participant I-7
Yes. The company gives you some order of magnitude. For the smaller segments, you will try to find out if you're in the $50 to $75 million area; by the time you get to a larger enterprise, they'll put you within maybe $100 million. [TI 12/9, p. 3]
Committee/Staff/Observer
There's no way I can follow up that discussion without getting into the second question. What is wrong with FASB 14 and what would you like to see changed? [TI 12/9, p. 3]
Participant I-7
First of all, the guidelines are much too broad. The guidelines currently allow major companies in the US to provide the kind of vague information I talked about earlier. Secondly, the information is based solely on the sale side of the business. The reason I brought up the [one company] example and the [another company] business is to show you that, if you're going to do FASB 14 disclosure, on occasion the profit element is much more important in terms of giving a sense of where the business lies and what markets it serves. Again in this company, there are businesses that do over 30% margins that will distort the totals from a sales point of view. [TI 12/9, p. 3]
Participant I-6
In line with that comment on loose guidelines, I believe that FASB 14 suggests that if there is a seasonal pattern to sales it should be broken out. Two companies I can think of right away, one makes aluminum cans, the other propane cylinders, do something like 60% of their business in one quarter; yet, they don't give you any seasonal breakouts on the sales or profitability because they say they spread it over the year. So the guidelines for implementation of the accounting standard is the weakness, not necessarily the actual standard. [TI 12/9, p. 3-4]
Participant I-12
I like to raise a point that may be specific to financial companies and that is the notion of gross interest income versus net interest income. Using [name deleted] as an example, every year in the Chairman's letter, they tell us they have two major businesses: processing and clearing and the securities business. The whole text of the annual report is built around those two businesses. If you go to the numbers, you can find zero numbers that tell you anything about the processing and clearing business. One of the ways they get around FASB 14 is by defining revenues on a gross interest basis. If you have a balance sheet of $10, $20, $100 billion and 25% of it in overnight repos, you have a very large dollar amount of gross interest income. That is a distortion. [Two companies] do the same thing (defining segments in terms of gross interest income) thereby avoiding showing the differences between their commercial banking lending business and their newer businesses that are more investment banking oriented. It is interesting that [Participant I-7] handed out something on [name deleted]; I would ask you to look at the [name deleted's] financial services disclosure and tell me if there is any indication that they have massive balance sheet risk in lending. [TI 12/9, p. 4]
Committee/Staff/Observer
Is there anybody here for which FASB 14 is not an issue? Everybody feels that there is some problem with FASB 14? [TI 12/9, p. 4]
Participant I-7
I have had some discussions about this with my peers. If you are a store chain that is predominantly in the Northeast, I haven't heard our retail person complain about FASB 14. But I would also suggest to you that there aren't too many of those. [TI 12/9, p. 4]
Committee/Staff/Observer
Is it compliance with it or the way the standard is written? [TI 12/9, p. 4]
Participant I-8
I can't give you specific examples but there might be one company that will honor the spirit of FASB 14 and, although it might be 100% in the electronics business, it will recognize that there are differences within that business. Another company will not honor the spirit of FASB 14 and will make the statement that they are only in one industry, the electronics business, even though they may have three disparate segments. [TI 12/9, p. 5]
Participant I-7
The guidelines have to be tightened up and there has to be additions to the guidelines. For example, where you have a series of businesses where 20% of the sales or earnings of the business comes from a specific unit within the total, that should be shown separately. You can then move on from that point to make FASB 14 more informational than it currently is. [Also included in 3(b)] [TI 12/9, p. 5]
Participant I-6
I would go further and lower the 20% to 15% because if a company has 10-15 units, it is hard to get a 20% unit; the 20% would only apply if you have a few dominant units. [Also included in 3(b)] [TI 12/9, p. 5]
Participant I-4
We don't normally deal with companies the size of [one company] with this many disparate operations, or [another company]. But it is clear that in the companies that we see, that when you begin to discuss their operations by looking at segmented earnings and sales information out of the 10-K or the annual report, they look at you dumbfounded because by and large they aren't running their businesses this way. They aren't reflecting the businesses internally this way and, in a lot of cases, this kind of work goes a fair way to obfuscate businesses that either are not doing terribly well, or absorbing too much capital or losing money, or businesses that for competitive reasons are doing too well. It is very unclear looking at this information that you can really get a sense of how the firm is being managed. [TI 12/9, p. 5]
Participant I-8
A lot of times I will look at segment reporting, and then I will ask for an organization chart because the way the company is organized and the way the different businesses are grouped do not resemble at all what is presented in the annual report. [TI 12/9, p. 6]
Participant I-7
The answer is relatively easy. I want a company to report to me the way they report internally. I don't want to spend months or years trying to understand that. [Also included in 3(b)] [TI 12/9, p. 6]
[Context] Meeting of the Investor Discussion Group on January 13, 1993. Part of the meeting was devoted to the topic of disclosure about operating opportunities and risks. During the discussion, an investor made a comment related to his previous criticism of current segment reporting.
Participant I-7
You all know what we think of the information coming out of FASB 14. Consequently, I'm not sure that we would be getting anything better setting up an FASB pronouncement relative to an MD&A than we get with FASB 14. But anything is better than what we have now, so go for it. [Also included in 10(b) and 13] [TI 1/13, p. 50]
[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of structure and process. During the discussion, a comment was made on segment reporting.
Participant I-7
There is one body and one body only [for ensuring wide acceptance of the Special Committee's final recommendations] and that is the SEC. I headed one of the AIMR's subcommittee for over 20 years, and 18 of those 20 years we have been going after better segment reporting; in fact, no company could get an award if they didn't report under FAS 14. But the SEC did not put any teeth in the group in terms of forcing the requirement and there just wasn't any change. If you're going to try implementing change, you're going to need the SEC. [Also included in 18(c)] [TI 3/17, p. 65]
[Context] Meeting of the Creditor Discussion Group on December 8, 1992. Part of the meeting was devoted to the topic of disaggregated information.
Participant C-1
Segment information is probably the most difficult information to get. One of the key examples is [name deleted] with [its] credit; they were required to consolidate that and they did, and all of a sudden when they ended up selling it, people began to realize it was such a significant part of cash flow. You can break segments down any way you want (for example, foreign versus domestic) and the ability to look at earnings and cash flow on either one, or different lines of business. It's very hard to look at segment information. [Also included in 1(b)] [TC 12/8, p. 18]
Participant C-13
I'd back that up. I'm sure you're going to hear the same thing or have the same thing from the equity side. The quality of segment information that's presently being provided isn't adequate. There are far too many changes in definitions, there are far too broad definitions of materiality. There needs to be a great deal more discipline in terms of segment definition, materiality, and the quality of segment reporting. [TC 12/8, p. 18]
Participant C-9
Regarding financial institutions, under the segment and the current reporting guidelines for segments, a bank is a bank, and that's one segment, so you don't get any breakdown at all. And so I guess I'd go for segments of segments to get an idea of the viability of the underlying businesses within any institution. [TC 12/8, p. 18]
Participant C-3
I think the way financial institutions have looked at the current segment reporting rules is that if I service a certain customer and provide different types of services to that customer, it's one segment, because it's one customer. And I wonder whether the rules ought to be geared to the types of services that are being provided and the types of revenues that are being generated. [Also included in 3(b)] [TC 12/8, p. 18]
Participant C-12
I don't have a good answer, but the information could be broken down by management reporting categories. That's ironic that when we look at a finance company report or a bank report, they're in one line of business; but if you talk to them, you talk to a half a dozen people, and they tell you about the different discrete businesses they are in. They're already preparing that information. [Also included in 3(b)] [TC 12/8, p. 18-19]
Participant C-4
One problem with segment reporting is that a lot of the companies that are required to report on a segment basis don't report internally on that basis. If we could somehow tie the corporate structure with subsidiaries and match that to the segments, it would be a lot more helpful for analyzing the segment results. [Also included in 3(b)] [TC 12/8, p. 19]
Participant C-5
I guess from the bank credit standpoint, we typically lend at the operating company level. So the legal entity reporting is very important to us because we are lending to different legal entities. Where we did get in holding company credit in the past, we've actually pushed down to operating company levels. Invariably we deal with specialized companies (each company or borrowing entity is a specialized industry) so there are no segmentations within that. We really do need legal entity reporting. And while segment reporting isn't bad, I don't think it really helps us as much as some of the other items. [Also included in 3(b)] [TC 12/8, p. 19]
Participant C-6
We're constantly running into managements that are saying they don't want to disclose segment information for competitive reasons. So we get a lot out of them when they come in and have a one on one discussion with us for an hour. We get more out of that than we'll get out of a financial statement. [Also included in 3(e)] [TC 12/8, p. 19]
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Participant C-12
I deal mostly with large investment grade institutions, and I find in general they do a pretty good job of giving me information I need to see to know what the core earnings are. For example, [name deleted] in its quarterly press release will give me a chart showing the changes quarter to quarter in ten different items, but they've never told me what they earn in credit card. One of the most basic segments I'd want to get just is not there. So, segment information is my first priority. [Also included in 3(b), 5(a), and 15] [TC 12/8, p. 28]
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Participant C-16
I'm in the leasing business, and we are continuously asked to extend credit to subsidiaries of major companies, and even subsidiaries of mid-sized companies. The absence of consolidating financial statements is difficult. I guess it's unrealistic to expect consolidating statements on a major company, but certainly for mid-sized companies I'd like to see more segment reporting a greater level of detail. [Also included in 3(b) and 15] [TC 12/8, p. 28]
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Participant C-9
If I take that further, I think that one reason we may not be getting segment information is I don't think big companies are being operated on that basis. As you say, the banks are operated more on a relationship basis, and there is not always a bottom line accounting of some of those smaller, discrete products. But there are discrete products within the banking industry, the credit cards, the mortgage banking business, and I think there could be more effort on that score. And I think it would be a positive development for both the management of the companies and those of us who evaluate the companies. [Also included in 3(b)] [TC 12/8, p. 33]
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Participant C-5
There is a lot of compelling that we can do, but at some point you reach a point where you realize they don't have this quality of information. We're the only one asking for it. And it's not even a competition factor at this point, it's the preparation of the material. For example, some of the segment reporting; I mean they're lucky to get a balance sheet and income statement together, let alone segment reporting. It's not necessarily a matter of resisting or fighting or feeling they're so powerful in the relationship that they can tell us what we're allowed to have. It's really just lack of that understanding of the information. [Also included in 1(b)] [TC 12/8, p. 58]
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Participant C-9
My comments would harken back to lack of segment reporting. It's very difficult to really forecast much. In fact, being a debt analyst, we're really more concerned about the downside, and so I would have to use some sensitivity analysis to make sure that the fixed charges could be covered, and that there is an ongoing concern. But I'm not as concerned about the upside. [Also included in 1(c)] [TC 12/8, p. 68]
To improve financial reporting, from an analyst's point of view, [one analyst] recommended . . . the following. . . : [Also included in 1(b), 2(c), 8(d), 15, and 17(d)] [BEAR STEARNS, p. 2]
Include disaggregated disclosures by operating unit that would show revenues and operating income, cash flows and relative returns for each operating unit. [Also included in 1(b) and 15] [BEAR STEARNS, p. 2]
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[Context] For companies in the precious metals business, the Mining Industry Subcommittee of the AIMR Corporate Information Committee would like to see improvements in reporting the following:
Better segmented reporting, particularly in quarterly reports. [Also included in 15] [AIMR/CIC91, p. 2]
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[Context] The papers are a summary of a committee and staff members' discussions with selected sell-side analysts from Goldman Sachs.
[One analyst's] main complaint is the lack of segment information. He would like drug companies to report product segments by geographic area. He wants information on new products and their margins. [Also included in 1(b), 13, and 15] [GOLDMAN, p. 2]
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[Context] November 17, 1992, a committee member and staff met with a buy-side equity analyst. The materials for the first meeting of the Investor Discussion Group provided the basis for the discussion.
[I]mprovements in disaggregated information should be a high priority. The need [is emphasized] for improved information related to operations in different geographic areas because the risks, prospects for growth and profitability often differ widely depending on the geographic location of the business. [Also included in 15] [FREEDMAN, p. 3]