Operating segments must also be similar in five qualitative areas (i.e., 280-10-50-11(a) through ASC 280-10-50-11(e)) 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
- The nature of the products and services
- The nature of the production processes
- The type or class of customer for their products and services
- The methods used to distribute their products or provide their services
- 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, type (e.g., business, governmental, consumer), 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 illustrates 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.