11.1 Discontinued operations
5 min read•august 19, 2024
Discontinued operations are a crucial aspect of financial reporting, reflecting major business changes. They involve components of a company that have been disposed of or are , significantly impacting operations and financial results.
Proper accounting for discontinued operations requires specific criteria, separate financial statement presentation, and detailed disclosures. This ensures transparency for investors and stakeholders, allowing them to assess the company's ongoing performance and future prospects accurately.
Definition of discontinued operations
- Discontinued operations refer to a component of an entity that has been disposed of or is classified as held for sale
- Represents a separate major line of business or geographical area of operations
- Discontinuing a component has a significant impact on an entity's operations and financial results
Criteria for classification as discontinued operations
- The component must be a separate major line of business or geographical area of operations
- The entity must have a single coordinated plan to dispose of the component
- The disposal must be expected to be completed within one year from the date of classification as held for sale, with limited exceptions
- The component's operations and cash flows must be clearly distinguishable from the rest of the entity
Financial statement presentation of discontinued operations
Income statement reporting
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- Results of discontinued operations are reported separately from continuing operations
- Income or loss from discontinued operations is presented as a single amount on the face of the income statement, net of tax
- Comparative income statements are restated to segregate discontinued operations from continuing operations
Balance sheet reporting
- Assets and liabilities of discontinued operations are presented separately from other assets and liabilities on the balance sheet
- Assets are measured at the lower of carrying amount or less costs to sell
- Liabilities directly associated with the discontinued operations are also presented separately
Cash flow statement reporting
- are disclosed separately from cash flows of continuing operations
- Cash flows are classified into operating, investing, and financing activities
- Comparative cash flow statements are restated to segregate discontinued operations
Disclosure requirements for discontinued operations
Description of discontinued operations
- The nature of the discontinued operations (line of business or geographical area)
- The date and manner of disposal or expected disposal
- The gain or loss recognized on the disposal, if any
Timing of discontinuance
- The period in which the discontinued operations are classified as held for sale
- The expected completion date of the disposal
Assets and liabilities of discontinued operations
- Major classes of assets and liabilities classified as held for sale
- Depreciation and amortization cease upon classification as held for sale
Income and expenses of discontinued operations
- Revenue, expenses, and pre-tax profit or loss of discontinued operations
- Income tax expense related to the discontinued operations
- Gain or loss recognized on the remeasurement of assets to fair value less costs to sell
Cash flows of discontinued operations
- Net cash flows attributable to operating, investing, and financing activities of discontinued operations
Accounting for disposal of discontinued operations
Measurement of assets and liabilities
- Assets are measured at the lower of carrying amount or fair value less costs to sell
- Liabilities directly associated with the discontinued operations are also measured at fair value
Gains and losses on disposal
- is recognized when the transaction is completed
- Calculated as the difference between the net proceeds from disposal and the carrying amount of the discontinued operations
Allocation of goodwill to discontinued operations
- Goodwill associated with the discontinued operations is included in the carrying amount for determining the gain or loss on disposal
- Allocated based on the relative fair values of the discontinued operations and the portion of the reporting unit retained
Tax considerations for discontinued operations
- Income tax expense related to the discontinued operations is disclosed separately
- Deferred tax assets and liabilities associated with the discontinued operations are presented separately
- Tax impact of the gain or loss on disposal is recognized in the period of disposal
Differences between US GAAP and IFRS
Definition and criteria
- US : Discontinued operations are a component of an entity that has been disposed of or is classified as held for sale
- IFRS: Discontinued operations are a component of an entity that has been disposed of or is classified as held for sale and represents a separate major line of business or geographical area of operations
Presentation and disclosure requirements
- US GAAP: Discontinued operations are presented separately on the face of the income statement, net of tax
- IFRS: Discontinued operations are presented in a separate section of the statement of comprehensive income, after the profit or loss from continuing operations
Examples of discontinued operations
Business segments vs product lines
- Business segment: A major line of business, such as a retail division of a company (clothing, electronics)
- Product line: A specific product or group of products within a business segment (smartphones, laptops)
Spinoffs and divestitures
- Spinoff: Creating a new independent company by distributing shares of a subsidiary to the parent company's shareholders (Dow Chemical's spinoff of Dow Corning)
- Divestiture: Selling a portion of a company's business or assets to another entity (General Electric's sale of its appliances business to Haier)
Auditing considerations for discontinued operations
- Assess the appropriateness of the classification as discontinued operations
- Verify the accuracy and completeness of the disclosures related to discontinued operations
- Evaluate the valuation of assets and liabilities classified as held for sale
- Review the calculation of the gain or loss on disposal and its tax implications
Impact on financial ratios and analysis
- Profitability ratios (return on assets, return on equity) may be affected by the exclusion of discontinued operations
- Liquidity ratios (current ratio, quick ratio) may change due to the of assets and liabilities held for sale
- Comparative analysis should consider the impact of discontinued operations on the entity's financial performance and position over time
Key Terms to Review (16)
ASC 205-20: ASC 205-20 is an accounting standard that provides guidance on the reporting and presentation of discontinued operations. This standard outlines how entities should classify, measure, and present discontinued operations in their financial statements, ensuring that the financial information is clear and useful for users.
Audit implications: Audit implications refer to the effects or considerations that specific financial reporting scenarios have on the audit process. These implications can influence how auditors assess financial statements, evaluate internal controls, and ensure compliance with accounting standards. Understanding audit implications is crucial for ensuring the integrity of financial reporting and identifying potential risks associated with remeasurement or discontinued operations.
Cash flows from discontinued operations: Cash flows from discontinued operations refer to the cash inflows and outflows that result from a segment of a business that has been disposed of or is classified as held for sale. This financial reporting measure is important because it allows investors and stakeholders to evaluate the impact of these operations on the overall cash flow of the company, distinguishing ongoing operations from those no longer contributing to future financial performance.
Disposal group: A disposal group refers to a collection of assets and liabilities that an entity intends to sell or otherwise dispose of in a single transaction. This grouping is significant because it allows organizations to report the financial impact of discontinuing certain operations in a more streamlined manner, facilitating clearer decision-making for stakeholders.
Earnings per share from discontinued operations: Earnings per share from discontinued operations is a financial metric that indicates the portion of a company's earnings allocated to each outstanding share of common stock, specifically from operations that have been discontinued. This metric provides investors with insights into the profitability generated from segments of the business that are no longer active, allowing for a clearer understanding of ongoing operations without the influence of those discontinued segments.
Fair Value: Fair value is the estimated price at which an asset could be bought or sold in a current transaction between willing parties, reflecting both the market conditions and the specific attributes of the asset. It is crucial for various financial reporting requirements and helps ensure that financial statements provide a true representation of a company's financial position.
GAAP: Generally Accepted Accounting Principles (GAAP) are a set of accounting standards, principles, and procedures used in financial reporting. They ensure consistency, reliability, and transparency in the financial statements, enabling stakeholders to make informed decisions based on comparable financial information.
Gain or loss on disposal: A gain or loss on disposal refers to the difference between the proceeds received from selling an asset and its carrying amount on the books at the time of sale. This concept is crucial in financial reporting as it helps determine the impact of asset sales on a company's financial position. Understanding this term also ties into how discontinued operations are treated in financial statements, as gains or losses from such disposals can significantly affect a company’s reported income.
Held for sale: Held for sale refers to assets that a company plans to sell rather than hold onto for long-term use, often classified as current assets on the balance sheet. These assets are expected to be sold within a year and are measured at the lower of their carrying amount or fair value less costs to sell, reflecting a company's intention to dispose of them promptly.
IFRS 5: IFRS 5 is an International Financial Reporting Standard that provides guidance on the accounting for non-current assets held for sale and discontinued operations. It establishes how entities should classify, measure, and disclose information about these assets, ensuring that investors and stakeholders receive relevant and reliable information about the financial impact of such operations.
Impairment Loss: Impairment loss refers to the reduction in the carrying amount of an asset when its recoverable amount falls below its book value. This concept is particularly important in assessing goodwill, indefinite-lived intangible assets, and equity method investments, as it ensures that these assets are not overstated on the financial statements.
International Financial Reporting Standards: International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB) that aim to create a common financial reporting language across the globe. These standards ensure transparency, accountability, and efficiency in financial markets, enabling investors and other stakeholders to make informed decisions. IFRS has a significant impact on how companies report their financial performance, particularly in areas like discontinued operations and reportable segments, where specific guidelines dictate how entities recognize, measure, and disclose information.
Net realizable value: Net realizable value (NRV) is the estimated selling price of an asset in the ordinary course of business, minus any costs that are necessary to make the sale. It is a crucial measure in accounting that helps determine the value of inventory and other assets, particularly when assessing their impairment. NRV plays an important role in financial reporting, especially for discontinued operations, as it influences how assets are valued on financial statements.
Operating income from discontinued operations: Operating income from discontinued operations refers to the financial results generated from a component of a business that has been disposed of or is classified as held for sale. This term is important as it distinguishes the performance of ongoing operations from those that are no longer part of the business, allowing for clearer financial analysis and reporting.
SEC Requirements: SEC requirements refer to the regulations set forth by the U.S. Securities and Exchange Commission (SEC) that govern the disclosure of financial information by publicly traded companies. These requirements ensure transparency and protect investors by mandating that companies provide accurate and timely information about their financial health, including details related to discontinued operations. This connection to discontinued operations is crucial as it informs stakeholders about the impact of such decisions on the overall financial statements.
Separate Presentation: Separate presentation refers to the method of reporting discontinued operations distinctly in financial statements, allowing stakeholders to easily identify the financial impact of such operations on a company's overall performance. This approach enhances transparency by clearly distinguishing ongoing operations from those that have been or will be disposed of, thus providing a clearer picture of a company's financial health and operational focus.