What Is Discontinued Operation?

A comprehensive guide on Discontinued Operation including its definition, reporting, and implications in financial statements.

Discontinued operations refer to the sale, disposal, or planned sale in the near future of a distinct business segment such as a product line or a class of customer. The financial results of these operations are reported separately in the income statement to provide clear insight into the company’s ongoing performance.

Definition

A discontinued operation is a component of a business or an entity that either has been disposed of or is classified as held for sale. This component:

• Represents a separate major line of business or geographical area of operations
• Is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations
• Is a subsidiary acquired exclusively with a view to resale

Reporting

The results of a discontinued operation must be reported separately in the income statement as a separate line item, after income from continuing operations and before extraordinary items. This helps in distinguishing the ongoing activities of the company from those that are no longer part of the regular business operations.

Income Statement Example:

1. Income from continuing operations

• Income from discontinued operations
  • (Gain/Loss from disposal of discontinued operations)
  • (Operating income/expenses of discontinued operations)

3. Extraordinary items

Types of Discontinued Operations

Discontinued operations can occur in different forms, depending on the nature and extent of the business segment being disposed of.

Full Disposal

Complete sale or shutdown of a business division or subsidiary that had a substantial impact on the company’s operations.

Partial Sale

Sale of a portion of a division that significant enough to warrant separate disclosure.

Planned Sale

Operations that are classified as held for sale but have not yet been sold. The criteria generally include the expectation of the sale within one year, among others.

Special Considerations

GAAP vs. IFRS

U.S. GAAP

• Requires separation and detailed disclosures for discontinued operations.

IFRS

• Generally aligns with U.S. GAAP but emphasizes components of an entity as opposed to segments.

Timing and Classification

For an operation to be classified as discontinued, a clear exit plan must be in place, and significant changes to the said plan must be disclosed.

Historical Context

Evolution of Reporting Standards

Historically, companies could simply lump gains or losses from discontinued operations with continuing operations, leading to a lack of transparency. The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have since established rules to improve clarity.

Applicability

Financial Analysis

Distinguishing discontinued operations helps investors and analysts better understand the company’s enduring profitability and operational focus.

Strategic Decisions

Companies may decide to discontinue operations to focus resources on more lucrative segments, adapt to market changes, or streamline operations.

Comparisons

Discontinued Operations vs. Extraordinary Items

• Discontinued Operations: Relate to specific segments or business lines planned for disposal.
• Extraordinary Items: Unusual and infrequent events affecting the company’s financial outcomes.

Related Terms

• Continuing Operations: Refers to the core business activities that are expected to provide revenue and profit for the foreseeable future.
• Restructuring Cost: Cost or expense associated with reorganizing and restructuring the company’s operations, which can sometimes coincide with discontinued operations.
• Gain/Loss on Disposal: The financial gain or loss resulting from the sale or closure of a division or business segment.

FAQs

Why are discontinued operations reported separately?

To provide clear and accurate financial results, allowing investors and stakeholders to distinguish ongoing operational performance from those that have been or will be terminated.

How does the sale of discontinued operations impact a company's financial health?

It can both improve or harm the company’s financial health depending on whether it eliminates underperforming segments or creates significant short-term losses.

What disclosures are required for discontinued operations?

Detailed disclosures including the profit/loss from discontinued operations, segmental information, and any expected gains/losses from the disposal process.

References

1. Financial Accounting Standards Board (FASB).
2. International Accounting Standards Board (IASB).
3. Investor and financial analyst reports.

Summary

Discontinued operations are a crucial aspect of financial reporting that offers transparency and clarity regarding the performance and strategic direction of a company. By segregating the income statement items, stakeholders gain a clearer view of the continuing activities, financial health, and potential future profitability of the entity. Understanding and accurately reporting these operations, following standardized rules, are fundamental in maintaining integrity and clarity in financial statements.