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:
- Income from continuing operations
- Income from discontinued operations
- (Gain/Loss from disposal of discontinued operations)
- (Operating income/expenses of discontinued operations)
- 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?
How does the sale of discontinued operations impact a company's financial health?
What disclosures are required for discontinued operations?
References
- Financial Accounting Standards Board (FASB).
- International Accounting Standards Board (IASB).
- 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.
