Discontinued Operations – Meaning, Disclosure And

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November 6, 2019

Discontinued Operations are that part or portion of a company’s core product that no longer
functions. Also, these parts are either held for sale or are already sold. For accounting
purposes, a company reports these parts separately from the continuing operations on the
income statement.

Disclosure of Discontinued Operations

For a company, a discontinued operation could result from structural changes such as a shift
in business models, sale of equipment, scrapping of product lines, and more. A company
needs to follow strict accounting rules to disclose all crucial details regarding ceased
operations. The company must also disclose its impact (if any) on the financial statements.

It does not mean that discontinued operations may not generate any profits for a business. In
fact, in cases where the company is in the process of selling a part, such operations continue
to generate profits. Still, the company must classify them as discontinued operations in the
financial statements.

Importance of Disclosure
Moreover, a company must provide a clear definition of the operation (or operations) that is
discontinued. Also, the management must clearly indicate that the discontinued operation is
no longer part of the core operations.

Such classification and information ensure that the external users get an accurate picture of
the company’s continued operations. Additionally, the company must also disclose any profit
or loss from the sale of a discontinued operation.

The distinction for discontinued operation also becomes very useful at the time of the
merger. Such classification gives a clear picture of the company’s potential cash flows.

Disclosure on Income Statement

When a company discontinues operations, it has to report several items on the financial
statements. Also, it is possible; the discontinued operation generates some revenue in the
current year in which the company shuts it down or sells it. Therefore, a company must
calculate the gain or loss from operations, including the applicable income tax.

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Such income tax is mostly a future benefit as discontinued operation usually leads to losses.
Now, when the company calculates its total net income, this gain or loss from the
discontinued operation must be included.

GAAP Treatment of Discontinued Operation

GAAP allows a company to report a discontinued operation on the financial statements if two
conditions are met. First, the part that the company plans to divest should result in
eliminating the cash flows. Second, after the company divests the part, it must not have any
significant involvement with the operations.

Under IFRS (International financial reporting standards), the criteria are slightly different.
IFRS also lays down two criteria. First, the company must dispose of or report it as being
held for sale. Second, the asset or part that the company wants to remove must be
distinguishable as a separate business.

Moreover, IFRS allows the equity method investments to be classified as held for sale. Also,
under IFRS, the discontinued operation may continue involvement with operations.

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Example (under GAAP)
The below scenarios will help you to understand discontinued operations better;

A company XYZ has several products under various different product lines. XYZ tracks
the cash flows for the product lines, but not for each product. Now, if it plans to cease
one of its products, then it must not classify the operations related to a single product
as a discontinued operation as there is no way to track cash flows.
Now XYZ plans to scrap one full product line. Since the company tracks cash flows for
the product lines, it must classify it as a discontinued operation.

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 XYZ also runs retail stores. It sells one store and agrees to supply the products to the
buyer of the store. In this case, XYZ will continue to get the majority of cash flows from
the same store. So, even though there is a change in the ownership, XYZ shouldn’t
classify it as a discontinued operation.
Suppose XYZ sells a few product lines. The sale agreement states that the buyer will
pay XYZ a 5% royalty from the sale coming from these product lines for the next five
years. In this case, XYZ will not have any continuing operational involvement in the
product lines that it sold. So, the cash flows or the royalty is indirect, and therefore, it
must classify the product lines as discontinued operations.

Format
If the conditions (under GAAP) are met, then the business must show the result of the
discontinued operations in a separate section in the income statement. Also, if there is any
gain or loss on disposal, then it should also come in the discontinued operations section.
Below is the sample of how you should show operations that are discontinued in the income
statement;

Income from continuing operations before income taxes $30,000,000

Income taxes (10,500,000)

Income from continuing operations $19,500,000

Discontinued operations

Loss from operations of discontinued business component (12,000,000)

Income tax benefit 3,100,000

Loss on discontinued operations (8,900,000)

Net income $10,600,000

Adjustments to Discontinued Operations

A company may discontinue an operation in the current year, but there might be some
related transactions that may come up after the disposal transaction. Considering the
adjustments for these were previously reported under discontinued operations, the company
must then adjust them separately in the discontinued operation section of the income
statement, provided they meet the GAAP requirements. Some examples of these
adjustments are;

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Contingent liabilities – if a company is able to resolve any such liability related to the
disposal transaction, then it must come as an adjustment. For example, any site remediation
liabilities retained by the seller.
Contingent terms – if a company resolves any contingencies related to the terms of the
disposal transaction, then it must be adjusted for. For example, any adjustment to the initial
price paid.
Benefit plan obligations – if such obligations occur within a year of the disposal
transaction, then the company must classify it as discontinued operations. For example,
post-employment benefits.
Interest on debt – if the buyer of a discontinued operation takes over any related debt, then
the seller should classify any interest expense borne by it under discontinued operation.1–3

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