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Segment reporting transparency--caveat emptor: financial analysts, M&A managers, and others need to understand The required segment reporting disclosures under SFAS no. 131. The authors offer some of its key points and a glimpse into the managerial Decision-making processes of three industrial companies.

Article Excerpt
EXECUTIVE SUMMARY Cooper Tire & Rubber adheres to the standards prescribed in SFAS No. 131, whereas Briggs & Stratton and Caterpillar follow the "management approach" in reconciling their segment numbers to their enterprise numbers. Despite their diverging from SFAS No. 131, the annual reports of the latter two companies received "clean opinions" from their auditors.

For companies growing their businesses through acquisition, in contrast to so-called "organic growth," the right path may mean acquiring a segment or segments of another company rather than the entire enterprise. Financial analysts, merger and acquisition managers, and others researching the strengths and weaknesses of competitors should be interested in understanding the required segment reporting disclosures under Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information."

In this article we delve into the key aspects of SFAS No. 131 that have an impact on important strategic business growth considerations. We provide an overview of current financial reporting requirements under the Statement, followed by an analysis of the SFAS No. 131 reporting by three industrial companies--Cooper Tire & Rubber Co., Briggs & Stratton Corp., and Caterpillar, Inc.--with a focus on the value of their operating segment disclosures to those in financial management, business development, and managerial accounting. We also provide insights into the opportunities and pitfalls associated with understanding contemporary segment reporting.

SEGMENT DISCLOSURES ZERO IN

As stated in SFAS No. 131, paragraph 20, the objective of segment reporting is to provide information to interested parties about:

* The different types of business activities that an enterprise engages in and

* The different economic environments in which it operates.

This information helps readers of financial statements understand:

* The divisional structure of the business,

* Enterprise performance, and

* Corporate cash flows.

Paragraph 2 requires a "management approach" to reporting segment information. This approach is based on the divisional structure that the company utilizes to make operating decisions. Therefore, segments are defined from the management's vantage point.

Management organizes the business for decision-making purposes and to evaluate performance. Segments are identified as a function of an entity's internal structuring, and an internal organization chart should illuminate how management thinks about its business segments. Under SFAS No. 131, no other approach is allowed. The components of this divisional structure are referred to as "operating segments." W. David Albrecht, an accounting professor at Bowling Green State University, states with regard to the "management approach" that:

"Disclosing information about the structure of
an enterprise's internal organization and its means
of evaluating performance are important because
it discloses management's insights into the overall
production process. It highlights the opportunities
and risks management believes are important.
For example, a disclosure of the current
structure might prompt a user to ask, 'Why is the
enterprise organized like this?'

"As answers are uncovered, user assessment of
risks and rewards should produce a more efficient
allocation of capital. In addition, if users can 'see
the enterprise through the eyes of management,'
they should be better able to predict managerial
actions and reactions that can affect an enterprise's
prospects for future cash flows." (1)


DECISION-MAKING INFORMATION REVEALED

Because information about those operating segments is already being generated for management's use, the incremental cost of providing information could be relatively low. The Financial Accounting Standards Board (FASB) chose to require that companies disclose the same information externally as they use internally for decision making instead of mandating a specific format for assessing segment performance. This information has the potential to provide users with additional insights into the managerial decision-making process.

It is thought that identifying segments based on the structure...

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