Academic journal article Journal of Accountancy

Improving Internal Control over Segment Reporting: The Principles of ASC Topic 280 Pave the Way toward Meeting Financial Reporting Objectives

Academic journal article Journal of Accountancy

Improving Internal Control over Segment Reporting: The Principles of ASC Topic 280 Pave the Way toward Meeting Financial Reporting Objectives

Article excerpt

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. It is worth noting that in its annual report for 2015, the company acknowledged a material weakness in its internal controls over segment reporting in prior years, which contributed to faulty segment reporting--from 2012 to the first quarter of 2014, PowerSecure disclosed one reportable segment, when it should have identified and reported multiple segments.

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

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

* Identification of the chief operating decision-maker (CODM);

* Identification of operating segments; and

* Aggregation of operating segments.


According to Topic 280, the CODM refers to a specific function within the company that allocates resources to and assesses performance of the segments of a public entity, rather than a manager with a specific tide. Identifying the CODM is a critical aspect of segment reporting, as then-SEC 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 ultimate decision-making authority. Furthermore, the distinction between any strategic and operating decisions is important as the latter pertains to the entity's day-to-day operational decisions. The identified CODM evaluates the entity's operating results to assess performance and to allocate resources. For instance, in its comment letter to NRG Energy Inc., dated Aug. 20, 2015 (File No. 001-15891), 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 segment
   manager. Please tell us in more detail how you
   considered the guidance in ASC [Paragraph]
   280-10-50-7 when concluding that these
   individuals are not operating segment 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 segment manager.

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

A company is well-advised to maintain an organization chart with detailed documentation of the various roles, in particular the segment managers, who are directly accountable to and maintain regular contact with the CODM to discuss operating activities, financial results, forecasts, or plans for the segment. …

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