Segment Reporting: Analysis of the Impact on the Banking Industry

Journal of Bank Cost & Management Accounting, The, 2003 by Link, Kevin W

This paper summarizes a study on the application of FASB Statement 131, Reporting Disaggregated Information about a Business Enterprise, and the degree to which any consistencies exist in the banking industry. Samples of 8 top-50 banks' were surveyed to assess the interpretation and implementation of segment reporting. Specifically, this research evaluated the following:

1. Are there consistent segment definitions?

2. Are similar performance measurement methodologies used in addressing the profitability of each segment?

3. Are there consistent policies for restating segment financial information?

4. What resources are required to develop internal reporting and segment reporting?

5. Has segment reporting improved the disclosure of relevant information around the different business activities of the industry?

BACKGROUND

Operating segments are components of a company for which separate financial information is available and is evaluated regularly by the chief operating decision maker (CODM) in deciding how to allocate resources and in assessing performance.

Prior to 1998, detailed information for segments was only required annually, and requirements were vague. To improve this, FASB Statement 131 requires that internal segment financial information should be the basis for external segment reporting. "Analysts wanted what management was looking at."2

A 1999 survey conducted by Investor Relations Magazine found that 86% of the Association for Investment Management and Research (AIMR) members rated enhanced segment reporting as the second most important disclosure issue behind the reporting of extraordinary events.3 The prior standard, SFAS 14 - Financial Reporting of Segments of a Business Enterprise - had significant shortcomings in the definitions of a segment. As a result, most financial institutions chose to report all of its operations in a single, broadly defined industry segment. The Board established FASB 131 with the following objectives:

a. Better understand the enterprise's performance

b. Better assess the enterprise's prospects of future net cash flows

c. Make more informed judgments about the enterprise as a whole.4

The standard provided further definition of a segment and established quantitative guidelines on what should be reported separately. However, the sec recognized inconsistency among these definitions:

"In some cases, financial statements of public companies have not conformed to these requirements. We have seen instances where: (1) the internal reporting package included operating information on more segments than were disclosed in the financial statements; (2) those additional segments were disclosed in management's discussion and analysis (MD&A) or analysts' reports; and (3) the company's executives also discussed the additional segments in press releases or business periodicals."5

SEGMENT DEFINITIONS

FASB believed its new standard would have minimal organizational or reporting impact. Quite the contrary, some analysts have argued that companies may change their organizational structure to avoid segment reporting that may provide competitive insights.

According to a 2000 American Accounting Association study, six of 160 companies had realigned their organizational structure following the 1998 FASB statement. It was believed that this realignment was taken in an effort to avoid providing insights into the true financial results of the company. In all but one of the six cases, a further review of the segment analysis results in conflicting data between the introductory annual report material, the MD&A, and the segment reports.

The sec stated that "when reviewing segment information as part of its normal filing review and comment process, the staff is not reticent to ask registrants for a copy of internal reports or other materials supplied to the chief operating decisions maker of the company as well as analysts' reports and press releases. Consequently, if the segment information provided in the financial statements does not reflect a similar breakdown of company segments as is evident in the internal reports and other materials, the staff will seek amendment of the registrant's filing."6

Table 1 reflects the common segments reported in the survey.

Although little consistency exists among the reporting segments defined above, the segmentation of retail banking from commercial baking is common. Only two of the eight organizations separated their Mortgage Banking practice, although six of these banks have a significant mortgage operation.

According to the survey conducted for this research, 100% of the banks define their segments along line of business, although many have internal reports reflecting geography as well. FASB 131 stipulates that organizations who manage along both geography and line of business should report the operating segments based on line of business.

Seven of the eight banks reported having centralized services that perform operations or services for all the segments. In all seven cases, the expenses of these centers are allocated 100% to the segments. The management of these shared services varied from an executive in the corporate segment to an executive in one of the line of businesses.