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 held for sale, 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
- 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 fair value less costs to sell
- Liabilities directly associated with the discontinued operations are also presented separately
Cash flow statement reporting
- Cash flows from discontinued operations 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
- Gain or loss 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 GAAP: 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 separate presentation 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