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Once the operating segments of a reporting entity are identified, the guidance permits aggregation of two or more operating segments if they exhibit similar economic characteristics and other operating similarities.
The FASB decided that if operating segments have characteristics so similar that they were expected to have essentially the same future prospects, separate reporting of segment information would not add significantly to an investor’s understanding of the reporting entity. Therefore, aggregation of two or more operating segments is permitted if they have similar economic characteristics (referred to in this chapter as the quantitative aggregation criteria) and have similarity in all of the other areas identified in ASC 280-10-50-11 (referred to in this chapter as the qualitative aggregation criteria). However, a reporting entity is not required to aggregate operating segments even if all of the aggregation conditions are met.
ASC 280-10-50-11 details the criteria that must be met in order to aggregate operating segments.

Excerpt from ASC 280-10-50-11

Operating segments often exhibit similar long-term financial performance if they have similar economic characteristics. For example, similar long-term average gross margins for two operating segments would be expected if their economic characteristics were similar. Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the objective and basic principles of this Subtopic, if the segments have similar economic characteristics, and if the segments are similar in all of the following areas:

  1. The nature of the products and services
  2. The nature of the production processes
  3. The type or class of customer for their products and services
  4. The methods used to distribute their products or provide their services
  5. If applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.

Through comment letters to registrants and public statements, the SEC staff has stressed that meeting the quantitative and qualitative criteria is a high hurdle and their tolerance for differences in performance metrics and other qualitative characteristics is relatively low when assessing whether operating segments can be aggregated.

25.5.1 Quantitative aggregation criteria

The similarity of economic characteristics of two operating segments should be carefully evaluated from both a historical and expected future performance perspective. In practice, several years of historical and estimated future financial data are typically used for purposes of this evaluation. A reporting entity should consider not only the similarity of financial performance but also the economic conditions, exchange control regulations, and underlying currency risks, if applicable. If a reporting entity cannot demonstrate similar economic characteristics, then aggregation is not permitted. That is, it would not be appropriate to rely on the similarity of the qualitative aggregation criteria provided by ASC 280-10-50-11 to aggregate operating segments if they do not meet the quantitative criteria.
For example, assume a reporting entity sells centrally produced, identical products to similar classes of customers in two different countries in which the regulatory environments are the same. Operating results for each country are separately reported internally and meet the qualitative aggregation criteria. However, due to differences in selling price, and therefore profit margin, as well as differences in currency risk and exchange control, it may be difficult to support an assertion of similar economic characteristics. As a result, it may be challenging to support aggregating the individual country operating segments.
Through comments to registrants, the SEC staff has questioned whether the “similar economic characteristics” test was met when measuring the difference in financial performance between operating segments. We believe a reporting entity should consider the relative percentage difference of the operating measure and not just the absolute difference. For example, when the CODM uses gross margin to evaluate operating segment performance, the difference between a gross margin of 55% and 50% is a 5% absolute value difference but represents a 10% relative difference. Although there is no “bright line” when assessing similarity, operating segments with differences between performance measures of 5% or less likely would be considered economically similar, whereas differences in excess of 10% may not meet the economic similarity criterion for aggregation.
In some cases, a high percentage difference in the relative operating measure can result from a relatively narrow range in the actual, or absolute, operating measure (e.g., a reporting entity with operating segments having gross margins of 2% and 3% would differ by only 1% in terms of absolute value, but that 1% would represent a 50% difference in relative values). In these circumstances, a reporting entity may want to consider other factors in addition to the relative operating measure to evaluate the similarity of economic characteristics, including trends in sales growth, return on assets employed, and operating cash flows, as well as any other performance measures regularly reviewed by the CODM.
While the similarity of long-term average gross margins is a particularly important factor and is included as an example in ASC 280-10-50-11, when a reporting entity is determining whether the economic characteristics of its operating segments are similar, other relevant factors should also be considered. For instance, the similarity of the performance measures that are regularly reviewed by the CODM, as well as other performance measures, such as trends in sales growth, returns on assets employed, and operating cash flows, should also be evaluated. Competitive and operating risks associated with each operating segment should be considered as these factors could impact prospective results of the segments. When assessing similarities and differences between operating segments, the evaluation should be made considering how wide or narrow the reporting entity’s breadth of business activities is and the economic environment in which they operate. Two or more operating segments considered to have similar long-term performance should be impacted similarly by events that have significant economic consequences.
Management should document its basis for concluding that operating segments are economically similar and should update the analysis on an annual basis, or more frequently if conditions that affect economic similarity change. In some circumstances, “temporary” dissimilarity in economic characteristics among operating segments may not necessarily preclude aggregation of operating segments if long-term economic similarity can still be demonstrated based on credible projections of future operations. Accordingly, a current change in operating performance may not necessarily result in a change to the composition of the reportable segments.
A reporting entity should monitor and consider whether its operating segment determinations are consistent with its publicly available information and disclosures. For example, press releases, investor presentations, analyst conference calls, and non-financial statement sections of SEC filings often include information regarding the nature of products and services, the type and class of customers, and how the reporting entity addresses its various market segments. If such information is not consistent with a reporting entity’s operating segment determinations, it may call into question those segment determinations.
Question FSP 25-4 address the aggregation of a start-up and a mature business into a single segment.
Question FSP 25-4
Assuming all other qualitative aggregation criteria are met, would a reporting entity be precluded from aggregating a start-up business with mature businesses based solely on the fact that the current economic characteristics of the start-up business differ from those of its mature businesses?
PwC response
No. One of the objectives of segment disclosures is to help users assess the future prospects of a reporting entity’s business. Further, ASC 280-10-50-11 indicates that operating segments with similar economic characteristics often exhibit similar long-term financial performance. Accordingly, to the extent that the future financial performance (including the competitive and operating risks) of the start-up business is expected to be similar to that of a reporting entity’s mature businesses in the near term, the economic characteristics requirement for aggregation would be satisfied.
For example, a retail chain may have mature store locations in five major cities. In the current year, the retail chain opens additional stores in those cities. Each store constitutes a separate operating segment because the CODM of the retail chain reviews financial results and makes decisions on a store-by-store basis. The retail stores meet all of the qualitative aggregation criteria. These “start-up” stores may meet the economic similarities requirement for aggregation with mature stores if management can establish that the financial performance of the mature and new stores is expected to converge in the near term.

Question FSP 25-5 addresses aggregation of a newly acquired business into an existing operating segment.
Question FSP 25-5
Assuming all other qualitative aggregation criteria are met, would a reporting entity be precluded from aggregating a newly-acquired operating segment with its existing operating segment if the historical economic characteristics of the acquired operating segment are not similar?
PwC response
It depends. The differing historical results of the newly-acquired operating segment compared to the reporting entity’s existing operating segment may indicate that the economic characteristics of the two operating segments are not similar. However, the seller’s historical results may not be relevant to future performance; therefore, the reporting entity should evaluate the newly-acquired operating segment’s future prospects. This evaluation would include the newly-acquired operating segment’s budget and the actions that management has taken or expects to take shortly after the acquisition. There should also be an evaluation of the achievability of management’s proposed changes to the acquired operating segment. If, after evaluating the future prospects, the two operating segments are expected to be economically similar within the near term, the two operating segments may be aggregated.

25.5.2 Qualitative aggregation criteria

Operating segments must also be similar in five qualitative areas (i.e., criteria (a) through (e) of 280-10-50-11) to be aggregated. The qualitative criteria are equally applicable to reporting entities with components organized based on products or services and those organized by geographic area.
ASC 280 includes the following five qualitative areas:

Excerpt from ASC 280-10-50-11

  1. The nature of the products and services
  2. The nature of the production processes
  3. The type or class of customer for their products and services
  4. The methods used to distribute their products or provide their services
  5. If applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.

The nature of products and services
Products and services are generally similar when they have the same customer utility. For example, two operating segments that produce products that can be substituted for each other may be considered similar.
Operating segments that represent different components of a vertically integrated operation require judgment and typically should not be aggregated solely on the basis that they comprise a single end product or service. This is because the specific product or service that each of the vertically integrated operating segments contributes to the end product could differ. The operations that produce each component of the end product should be evaluated separately, particularly if there is a separate market for each of the components.
The nature of production processes
Production processes include the types of machinery and facilities that produce a specific product and the types of labor and raw materials used in the production process. Production processes are often similar if operating segments (which sell similar products) produce the products in a central manufacturing facility. When operating segments source all or most of their products from external suppliers, the production processes of the outsourced items should be evaluated.
For reporting entities that provide services, the similarity of the service delivery process and the training and skills of the employees delivering the services should be evaluated.
The type or class of customer for the products and services
The type or class of customer may be distinguished by several different factors, including the customer’s industry, use of the product and service, purchasing power and location, and the sales and marketing approach directed to the customer. Often, similar classes of customers will react to changes in economic events in a similar fashion. As such, reporting entities should consider whether they have similar strategies for reacting to economic events impacting their operating segments. Differences in approach between their operating segments may suggest that the segments are geared toward different classes of customers.
The methods used to distribute the products or services
For a reporting entity with product sales, different methods of distribution could be used for sales directly to end users versus those to wholesalers or distributors. Methods of distribution to end users should further be evaluated for similarities or differences based on whether the sales are made through the internet, by catalog, or through retail locations.
If applicable, the nature of the regulatory environment
Many industries and services have specific regulations to which they are subject. The regulatory environment criterion applies to those situations in which a unique regulatory environment relating to each operating segment exists. For example, in a situation in which a reporting entity has a banking operating segment and an insurance operating segment, each part of the business operates in a unique regulatory environment. In some cases, different regulatory agencies may still be considered similar if the nature and extent of the regulation are alike.
Example FSP 25-5 provides an illustration of the regulatory environment qualitative criterion.
EXAMPLE FSP 25-5
Understanding the regulatory environment criterion
FSP Corp is a liquor retailer that operates stores in the New York and Florida regions, each of which meets the definition of an operating segment. The state regulations for liquor retailers differ from state to state (e.g., licensing, purchases, days of operation). However, the economic characteristics are similar, as are the nature of the products, production process, type of customer, and distribution methods. For internal purposes, management prepares, and the CODM reviews, separate financial results for each region (New York and Florida). The principal reason for preparing the results separately is to maintain the information necessary to comply with state requirements and for tax-return preparation purposes.
Could FSP Corp aggregate the New York and Florida operating segments?
Analysis
While the Florida and New York regions are each operating segments, FSP Corp would not be precluded from combining these segments solely on the basis that the state regulations differ. In this case, while the specific regulations may vary by state, the nature of regulation (i.e., controlling the sale of liquor products) is the same in New York and Florida.
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