Page 14 of Tesla’s (NASDAQ:TSLA) 2017 10-K states:
We operate as two reportable segments: automotive and energy generation and storage.
The automotive segment includes the design, development, manufacturing, and sales of electric vehicles. The energy generation and storage segment includes the design, manufacture, installation, and sale or lease of stationary energy storage products and solar energy systems, and sale of electricity generated by our solar energy systems to customers.
As stated, Tesla has two reportable business segments, the automotive segment and the energy generation and storage segment.
What does “Full Disclosure” mean to the SEC and to the Financial Accounting Standards Board (FASB, which governs the accounting standards that public companies must comply with)? It is a basic Generally Accepted Accounting Principle (GAAP). As stated on page 1,314 of “Intermediate Accounting by Kieso, Weygandt, and Warfield, 2010:
The full disclosure principle calls for financial reporting of any financial facts significant enough to influence the judgment of an informed reader.”
The same page also states:
For example, recently the SEC required companies to provide expanded disclosures about their contractual obligations. In light of the off-balance sheet accounting frauds at companies like Enron, the benefits of these expanded disclosures seem fairly obvious to the investing public.”
I’ve stated it a number of times and I’ve seen other posters on SA state the same thing, and that is that Tesla does not seem transparent enough with its financial reporting. That thought came into focus when I thought about the company’s reportable business segments. I knew there was a specific standard or two that governed segment reporting. So, I decided to research the matter and see what information was required to be reported and then compare that with what Tesla reported, as well as what other companies, with more than one reportable segment reported.
The accounting standard governing business segment reporting is Statement of Financial Accounting Standards (SFAS) 131: Disclosures About Segments of an Enterprise and Related Information. SFAS 131 replaced SFAS 14: Financial Reporting for Segments of a Business Enterprise in 1997. The reason for the updated standard on business segment reporting was because financial analysts found SFAS 14 inadequate. (See paragraphs 42 and after of the Standard). They wanted financial statement data to be disaggregated to a greater degree than required by SFAS 14.
With FASB changing over to the accounting standards codification (ASC), this standard is now ASC 280: Segment Reporting, but it’s the same content as SFAS 131. Because the content is identical, I will refer to text from SFAS 131, instead of ASC 280. The codification is harder to access because you have to register at FASB’s website, so I can’t link to the text with it, whereas SFAS 131’s text is readily accessible.
SFAS 131 requires that a public business enterprise report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that’s evaluated regularly by the chief operating decision maker (CODM) in deciding how to allocate resources and in assessing performance. Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments.
The reason that SFAS 131 was created was to:
Better understand the enterprise’s performance through expanded disclosures. Better assess its prospects for future net cash flows. Make more informed judgments about the enterprise as a whole.
It appears that Tesla meets the technical requirements of SFAS 131: Disclosures About Segments of an Enterprise and Related Information, but has failed to comply with the spirit of the standard. That’s my opinion after researching this subject.
SFAS 131 requires that a public business enterprise report a measure of profit or loss, certain specific revenue and expense items, and assets by segment. It also requires reconciliations of total segment revenues, total segment profit or loss, total segment assets, and other amounts disclosed for segments to corresponding amounts in the enterprise’s general-purpose financial statements. Information about the revenues derived from the enterprise’s products or services, about the countries in which the enterprise earns revenues and hold assets, and about major customers also is required to be reported, regardless of whether that information is used in making operating decisions.
An operating segment of an enterprise is defined by SFAS 131, paragraph 10 as:
10 …a component of an enterprise:
a. That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise).
b. Whose operating results are regularly reviewed by the enterprise’s CODM to make decisions about resources to be allocated to the segment and assess its performance, and
c. For which discrete financial information is available.”
Then paragraph 12 states:
12. The term chief operating decision maker identifies a function, not necessarily a manager with a specific title. That function is to allocate resources to and assess the performance of the segments of an enterprise.”
This means that the CODM, as defined in the previous paragraph, may be a group of persons and not just one person.
The following defines what a “reportable business segment” is which requires disaggregated segment reporting:
18. An enterprise shall report separately information about an operating segment that meets any of the following quantitative thresholds:
a. Its reported revenue, including both sales to external customers and intersegment sales or transfers, is 10 percent or more of the combined revenue, internal and external, of all reported operating segments.
b. The absolute amount of its reported profit or loss is 10 percent or more of the greater, in absolute amount, of (1) the combined reported profit of all operating segments that did not report a loss or (2) the combined reported loss of all operating segments that did report a loss.
c. Its assets are 10 percent or more of the combined assets of all operating segments.
So, now we know what business segments are and which business segments must be reported separately from consolidated amounts.
I’m including here the SEC’s explanation of why it changed its guidance to conform to SFAS 131.
Let’s now examine, from SFAS 131, what is required to be disclosed by reported operating segments:
25. An enterprise shall disclose the following:
a. General information as described in paragraph 26
b. Information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement, as described in paragraphs 27-31
c. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other significant items to corresponding enterprise amounts as described in paragraph 32
d. Interim period information as described in paragraph 33.
26. An enterprise shall disclose the following general information:
a. Factors used to identify the enterprise’s reportable segments, including the basis of organization (for example, whether management has chosen to organize the enterprise around differences in products and services, geographic areas, regulatory environments, or a combination of factors and whether operating segments have been aggregated).
b. Types of products and services from which each reportable segment derives its revenues.”
Information about Profit or Loss and Assets
27. An enterprise shall report a measure of profit or loss and total assets for each reportable segment. An enterprise also shall disclose the following about each reportable segment if the specified amounts are included in the measure of segment profit or loss reviewed by the chief operating decision maker:
a. Revenues from external customers
b. Revenues from transactions with other operating segments of the same enterprise
c. Interest revenue
d. Interest expense
e. Depreciation, depletion, and amortization expense
f. Unusual items as described in paragraph 26 of APB Opinion No. 30, Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions
g. Equity in the net income of investees accounted for my the equity method
h. Income tax expense or benefit
i. Extraordinary items
j. Significant noncash items other than depreciation, depletion, and amortization expense.
28. An enterprise shall disclose the following about each reportable segment if the specified amounts are included in the determination of segment assets reviewed by the chief operating decision maker:
a. The amount of investment in equity method investees.
b. Total expenditures for additions to live-lived assets other than financial instruments, long-term customer relationships of a financial institution, mortgage and other servicing rights, deferred policy acquisition costs, and deferred tax assets.
Now we come to a very important part of the standard. It’s this paragraph that seems to be a loophole for Tesla to circumvent what was intended by SFAS 131.
29. The amount of each segment item reported shall be the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance. Adjustments and eliminations made in preparing an enterprise’s general-purpose financial statements and allocations of revenues, expenses, and gains or losses shall be included in determining reported segment profit or loss only if they are included in the measure of the segment’s profit or loss that’s used by the chief operating decision maker. Similarly, only those assets that are included in the measure of the segment’s assets that’s used by the chief operating decision maker shall be reported for that segment. If amounts are allocated to reported segment profit or loss or assets, those amounts shall be allocated on a reasonable basis.”
Are you still with me? It is a lot to digest. There is more, but I want to stop here and begin the analysis of Tesla’s disclosures. Tesla reports its business segment information under Note 23 of the 2017 10-K, pages 117 and 118:
Note 23 Segment Reporting and Information about Geographic Areas
We have two operating and reportable segments: (i) automotive and (ii) energy generation and storage. The automotive segment includes the design, development, manufacturing and sales of electric vehicles. Additionally, the automotive segment is also comprised of services and other, which includes after-sales vehicle services, used vehicle sales, powertrain sales and services by Grohmann. The energy generation and storage segment includes the design, manufacture, installation and sales of solar energy generation and energy storage products. Our CODM does not evaluate operating segments using asset or liability information. The following table presents revenues and gross margins by reportable segment (in thousands):”
Note on page 117 that Tesla’s “measure of profit or loss” which they use “for purposes of making decisions about allocating resources to the segment and assessing its performance” is Gross Profit.
At this point I have to ask: Really? You mean to say that Mr. Musk and Mr. Ahuja, or whoever the CODM is, meet with the people responsible for the two business segments to review operating performance and the only measure of profit or loss that they review is Gross Profit? Are you serious?
I mean, you have business segment operating expenses like:
Payroll for design, development, manufacturing, and sales. SG&A for both operating segments, like utilities, telephones both stationary and mobile, internet usage charges, and general office supplies for administrative employees and sales employees. Depreciation for general purpose office equipment like computers, printers, telephones, desks, chairs. Depreciation on the buildings that house administrative and sales employees. Amortization on computer software used to manage both segments. Marketing costs Other things I have not mentioned or thought of.
All of these costs can be easily identified with either the Automotive segment or the Energy Generation and Storage segment. I am certain that Tesla’s CODM reviews these business segment costs and reviews operating income or loss by business segment in order to assess operating performance for each segment. But, SFAS 131 doesn’t define what the term “a measure of profit or loss” is. Therefore, the Standard provides Tesla with a loophole whereby they are not required to disclose operating income or loss by business segment. As a consequence, in Tesla’s case the new Standard provides a loophole whereby less disaggregated financial information may be disclosed than the old one. That’s exactly the opposite of what was intended with the issuance of the new Standard.
To support my claim that Tesla’s CODM looks at details of operating performance on a segment level basis that go well beyond the Gross Profit level, Take a look at this article from October 25, 2017.
” Tesla said at the time of the acquisition it would cut costs by $150 million in the first full year after closing the deal, which will occur November 21, 2017. SolarCity cofounders Peter and Lyndon Rive have both left the company since it was acquired by Tesla. The Rives are cousins of Tesla CEO Elon Musk. “
The word “synergies,” however, means cost cutting, and at least some of the cost cutting will come in the form of layoffs.
Like all companies, Tesla conducts an annual performance review during which a manager and employee discuss the results that were achieved, as well as how those results were achieved, during the performance period. This includes both constructive feedback and recognition of top performers with additional compensation and equity awards, as well as promotions in many cases. As with any company, especially one of over 33,000 employees, performance reviews also occasionally result in employee departures. Tesla is continuing to grow and hire new employees around the world.”
SFAS 131 provides an example of Segment Information to be reported, in paragraph 122:
Diversified Company evaluates performance based on profit or loss from operations before income taxes not including nonrecurring gains and losses and foreign exchange gains and losses.”
Did you get that? The example in SFAS 131, itself, uses what to evaluate performance? Operating Income or Loss.
The example company also has a finance segment that meets the reportable segment criteria. Tesla has a finance division in its Auto Segment. That division doesn’t meet the reportable segment criteria? Interesting. Very interesting.
IMO, Tesla does, in fact, assess business segment performance at the operating income or loss level. My own accounting work experience tells me that. Common sense tells you that. I was born at night, but not last night. So, even though Tesla meets the technical requirements of SFAS 131, by reporting “a measure of profit or loss,” the company fails to comply with the very intent of the standard, in my opinion.
There’s another matter, also, the reporting of segment assets. Tesla doesn’t report their assets by segment, but only by a consolidated total. Again, it appears that Tesla meets the technical requirements of SFAS 131, but fails to comply with its spirit. Within Note 23 of the 2017 10-K, on page 117, Tesla states: Our CODM does not evaluate operating segments using asset or liability information.
Paragraph 29 of the standard states: “The amount of each segment item reported shall be the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance. “
So, with Tesla’s statement, they comply with the technical requirements of the standard since, according to the company, the CODM doesn’t evaluate operating segments using asset or liability information.
But, is it really true that Tesla doesn’t evaluate segment operating performance or the allocation of resources (assets) using asset information? Has Tesla consolidated SolarCity and reduced the amount of assets under its management, as a result? Yes, they have. Does Tesla continue to monitor and manage the amount of its assets, company wide? Obviously, they do. And what about “capex?” So if this isn’t reviewing resource allocation (assets) and making decisions about resource allocation (assets), then I’m from Mars. I think any public company manages the allocation of resources using asset information, as can readily be seen by the asset information provided by other enterprises with more than one segment. Ford (NYSE:F), GM (NYSE:GM), John Deere (NYSE:DE), GE (NYSE:GE), Johnson & Johnson (NYSE:JNJ), Caterpillar (NYSE:CAT), and every other company that I’ve researched, that has more than one business segment, provides operating income, asset information, depreciation, and other information by segment. But not Tesla. I find it hard to believe that Tesla doesn’t review and evaluate operating performance or resource allocation with asset information.
Let’s go on, now, and review a few other paragraphs of the standard.
32. An enterprise shall provide reconciliations of all of the following:
a. The total of the reportable segment’s revenues to the enterprise’s consolidated revenues.
b. The total of the reportable segments’ measures of profit or loss to the enterprise’s consolidated income before income taxes, extraordinary items, discontinued operations, and the cumulative effect of changes in accounting principles.
c. The total of the reportable segments’ assets to the enterprise’s consolidated assets.
d. The total of the reportable segments’ amounts for every other significant item of information disclosed to the corresponding consolidated amount.
All significant reconciling items shall be separately identified and described. For example, the amount of each significant adjustment to reconcile accounting methods used in determining segment profit or loss to the enterprise’s consolidated amounts shall be separately identified and described.
Tesla includes a reconciliation of its reportable segment revenues to consolidated revenues. But I don’t see a reconciliation of the reportable segments’ profit or loss to the consolidated income or loss before income taxes, extraordinary items, etc. And a reconciliation of the reportable segments’ assets to consolidated assets is missing.
Then there’s paragraph 38 about reporting revenues from external customers by geographic region, and long-lived assets by geographic region. Tesla complies with this.
Then there’s paragraph 39:
Information about Major Customers
39. An enterprise shall provide information about the extent of its reliance on its major customers. If revenues from transactions with a single external customer amount to 10 percent or more of an enterprise’s revenues, the enterprise shall disclose that fact, the total amount of revenues from each such customer, and the identity of the segment or segments reporting the revenues. The enterprise need not disclose the identity of a major customer or the amount of revenues that each segment reports from that customer.
Tesla doesn’t provide any information in this regard, so, apparently it doesn’t derive at least 10 percent of its revenues from just one customer.
So, that’s the standard and you can review it at FASB’s website here.
Let’s further evaluate the adequacy of Tesla’s disclosures about its business segments by revealing what was intended when SFAS 131 replaced SFAS 14.
First, let’s review the statements of the sole FASB Board Member (there are seven board members) who dissented from the issuance of SFAS 131:
This Statement was adopted by the affirmative votes of six members of the Financial Accounting Standards Board. Mr. Leisenring dissented.
Mr. Leisenring dissents from the issuance of this Statement because it does not define segment profit or loss and does not require that whatever measure of profit or loss is reported be consistent with the attribution of assets to reportable segments.
By not defining segment profit or loss, this Statement allows any measure of performance to be displayed as segment profit or loss as long as that measure is reviewed by the chief operating decision maker. Items of revenue and expense directly attributable to a given segment need not be included in the reported operating results of that segment, and no allocation of items not directly attributable to a given segment is required. As a consequence, an item that results directly from one segment’s activities can be excluded from that segment’s profit or loss. Mr. Leisenring believes that, minimally, this Statement should require that amounts directly incurred by or directly attributable to a segment be included in that segment’s profit or loss and that assets identified with a particular segment be consistent with the measurement of that segment’s profit of loss.
Mr. Leisenring supports trying to assist users as described in paragraph 3 of this Statement but believes it is very unlikely that will be accomplished, even with the required disclosures and reconciliations to the entity’s annual financial statements, because of the failure to define profit or loss and to impose any attribution or allocation requirements for the measure of profit or loss.
Mr Leisenring supports the management approach for defining reportable segments and supports disclosure of selected segment information in condensed financial statements of interim periods issued to shareholders. Mr. Leisenring believes, however, that the definitions of revenues, operating profit or loss, and identifiable assets in paragraph 10 of Statement 14 should be retained in this Statement and applied to segments identified by the management approach.
I concur with Mr. Leisenring. Without defining profit or loss, companies like Tesla can skirt the spirit and intent of the new standard, as we see being done in Tesla’s 10-K, in my opinion.
So, I have a question. Is there any “material” information which Note 23 of Tesla’s financials discloses that isn’t contained within its Consolidated Income Statement? Very little, in my opinion. The intent of SFAS 131 was that MORE disaggregated financial data would be disclosed than was disclosed under SFAS 14. That isn’t the case with Tesla.
Here is the intent of the new Standard, in paragraphs 42 through 45:
42. FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise, was issued in 1976. That Statement required that business enterprises report segment information on two bases: By industry and by geographic area. It also required disclosure of information about export sales and major customers.
43. The Board concluded at the time it issued Statement 14 that information about components of an enterprise, the products and services that it offers, its foreign operations, and its major customers is useful for understanding and making decisions about the enterprise as a whole……
44. In its 1993 position paper, Financial Reporting in the 1990s and Beyond, the Association for Investment Management and Research (AIMR) said:
(Segment data) is vital, essential, fundamental, indispensable, and integral to the investment analysis process. Analysts need to know and understand how the various components of a multifaceted enterprise behave economically. One weak member of the group is analogous to a section of blight on a piece of fruit – it has the potential to spread rot over the entirety. Even in the absence of weakness, different segments will generate dissimilar streams of cash flows to which are attached disparate risks and which bring about unique values. Thus, without disaggregation, there is no sensible way to predict the overall amounts, timing, or risks of a complete enterprise’s future cash flows. There is little dispute over the analytic usefulness of disaggregated financial data. (Pages 59 and 60).
45. Over the years, financial analysts consistently requested that financial statement data be disaggregated to a much greater degree than it is in current practice. Many analysts said that they found Statement 14 helpful but inadequate. In its 1993 position paper, the AIMR emphasized that:
There is no disagreement among AIMR members that segment information is totally vital to their work. There also is general agreement among them that the current segment reporting standard, Financial Accounting Standard No. 14, is inadequate.
Then, paragraph 93 of SFAS 131 states:
Although this Statement requires disclosure of more information about an individual operating segment than Statement 14 required for an industry segment, ….”
Clearly, what was intended with the new Standard was more disaggregated data, not less. But, with Tesla, less is more. I give Tesla a grade of F for this section of their 10-K. Their Business Segments are something of a “black box” due to the lack of disclosure about them.
In Contrast, I present John Deere’s Disclosure Note on Reported Segments. It’s three pages long:
I’ll wrap up the article with this. Where’s the beef? When businesses become materially diversified, investors and investment analysts want more information about the details behind the consolidated financial statements. In particular, they want Income Statement, Balance Sheet, and Cash Flow information on the individual segments that compose the total income or loss figures.
Much information is hidden in the consolidated numbers. If an investor or an analyst has only the consolidated figures, he or she cannot tell the extent to which differing product lines contribute to the company’s profitability (or lack of), risk and growth potential. Earnings of the individual segments enable investors and the analyst to evaluate the differences between segments in growth rate, risk, and profitability, and to forecast consolidated profits. SFAS 14 was written to better serve the investor and analysts by requiring segmented information be made available, including operating income or loss and the assets contributing to that income or loss. SFAS 131 replaced SFAS 14 so that even more and better segmented data would be made available. Tesla defeats the purpose for which SFAS 131 was issued, since it provides less information about operating income and assets (no data) than it would have been required to report under SFAS 14.
In short, take away Note 23 of Tesla’s 10-K and little material information has been omitted, meaning Note 23 tells us little more about the business segments than if the Note were not present.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may buy puts on Tesla when and if the price reaches $350
It is highly risky to short this stock. Please understand the risks fully before doing so.