Segment Profit/Loss and the Limitations of a “Management Approach”

GAAP’s “Management Approach” to segment reporting (ASC 280) requires firms to report segment profit/loss as the measure managers use when allocating resources internally across segments under the assumption that investors benefit from viewing segment performance through the eyes of management. We examine how segment performance measurement aligns with the way that investors use segment profit/loss measures externally. We first survey professional investors and find that they primarily use segment profit/loss to assess firm value and therefore desire measures focused on persistent income items that help predict future performance. Next, for a sample of public multi-segment firms from 2003 to 2018, we hand-collect details on the construction of firms’ segment profit/loss measures and compare them to the same firms’ valuation-focused measures (i.e., non-GAAP earnings and non-GAAP segment profit/loss). Relative to non-GAAP measures, ASC 280 segment profit/loss is significantly more likely to include less persistent items (e.g., restructuring charges) and exclude more persistent items (e.g., interest expense). ASC 280 segment profit/loss is also less predictive of future performance and less value relevant than non-GAAP measures. These differences are attributable to ASC 280 yielding segment profit/loss measures that focus on the controllability of items by segment managers instead of items’ persistence. Overall, ASC 280’s segment profit/loss exhibits misalignment between its internal use by managers (i.e., internal resource allocation) and its primary external use by investors (i.e., valuation), which limits its usefulness for investors. Our study informs market participants and standard setters considering the usefulness of segment disclosures.