In general, financial reporting focuses on the results of continuing operations. However, sometimes businesses sell or end a product line or another component. If such a transaction satisfies certain criteria under U.S. Generally Accepted Accounting Principles (GAAP), it must be reported as discontinued operations. However, due to previous complexities and confusion surrounding discontinued operations reporting rules, the Financial Accounting Standards Board (FASB) issued new guidelines in 2015.
As your business evolves, it is critical to fully understand reporting requirements – especially if you are making moves to sell or end a part of your business.
What’s in this article?
- What are discontinued operations?
- What is a recent example of discontinued operations?
- Why is it important to separate continuing and discontinued operations?
- What are the reporting standards for discontinued operations?
- How do I report discontinued operations on my income statement?
- What are the additional disclosure rules?
What are discontinued operations?
In the world of financial accounting, discontinued operations refer to the divested, shut down, or otherwise disposed of parts of a company’s central business or product line. Discontinued operations are reported separately from continuing operations on an income statement.
So what are continuing operations?
Continuing operations are exactly as they sound. They are ongoing concerns, businesses, products, lines, etc. that the company expects to engage in the foreseeable future.
What is a recent example of discontinued operations?
One notable example comes in the form of the 1994 Viacom acquisition of Paramount Studios. In order to pull off the deal, Viacom accumulated an excessive amount of debt. Therefore, the company began selling off assets and businesses to help pay the debt down.
Simon & Schuster, a major book publisher, was one of the businesses cut from Viacom. Ultimately, in 1998 the media giant sold Simon & Schuster’s educational operations to Pearson PLC, a global publisher, and the professional and reference operations to another company. Inherently, these deals impacted Viacom’s revenue and earnings in a few different ways.
First, when Viacom sold parts of Simon & Schuster it obtained incredible amounts of cash from the buyers. However, because it no longer owned certain operations lines, it lost all future rights to any of the ongoing revenue and profits those lines generated.
Therefore, in order to warn investors, it included a “Discontinued Operations” line-item entry. This entry explained to stakeholders that the money was earned from operations no longer a part of Viacom’s ongoing operations or holdings.
Why is it important to separate continuing and discontinued operations?
Companies evolve for a number of reasons. Times change and different parts of a business are affected by market forces, regulatory shifts, political environments, technological advancements and a wide swath of other factors. However, as companies elect to divest or cease product line operations, an asset group, or other component, it presents a problem when promoting past financial data to potential investors.
By differentiating the two categories – which is required by GAAP rules – it permits the company to highlight the ongoing and profitable aspects of the business. This allows investors, whether stockholders or brokers, to assign more accurate price-to-earnings ratio to predicted future performance.
What are the reporting standards for discontinued operations?
As FASB announced an overarching simplification initiative in 2014, it addressed discontinued operations as a specific issue needing greater clarification. Following up to their initial announcement, the Board passed a new accounting standard to take effect in 2015. Accounting Standards Update No. 2014-08, Presentation of Financial Statements and Property, Plant, and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, modified the criteria for reporting discontinued operations while simultaneously expanding the disclosures. It further acknowledged the main sources of confusion and inconsistencies related to reporting discontinued operations under U.S. GAAP guidance.
A component comprises operations and cash flows that are clearly distinguished, both operationally and for financial reporting purposes, from the rest of the company. Some examples are a reportable segment or operating segment, a reporting unit, a subsidiary or an asset group.
Prior to Update No. 2014-08, there were three necessary stipulations to classify a transaction as discontinued operations:
- The component had been disposed of or was classified as “held for sale.”
- The operations and cash flows of the component had been (or would have been) eliminated from the ongoing operations of the entity as a result of the disposal transaction.
- The entity did not have any significant continuing involvement in the operations of the component after the disposal transaction.
Under the old guidelines, some stakeholders believed that an excessive amount of disposals qualified. Further criticism pointed out the convoluted and complex definition of the transaction.
The FASB listened and made changes. As a result, ASU No. 2014-08 eliminates the second and third conditions listed above. Therefore, disposal of a component (including business activities) is reported in discontinued operations only if the disposal represents a “strategic shift” that has or will have a significant effect on the company’s operations and financial results. Examples include ridding of a major geographic area, line of business or equity method investment.
When such a shift occurs, the company is required to present, for each comparative period, the assets and liabilities of a disposal group that includes a discontinued operation separately in the asset and liability sections of a balance sheet.
While fewer transactions now qualify as discontinued operations, those that do satisfy the criteria require expanded disclosures for the periods in which operating results of the discontinued operations are presented in the income statement. For instance, companies must disclose major classes of line items constituting pretax profit or loss of the discontinued operation. Examples of major line item classes include revenue, cost of sales, depreciation and amortization, and interest expense.
Furthermore, companies are required to disclose either 1) the total operating and investing cash flows of the discontinued operations, or 2) the depreciation, amortization, capital expenditures, and significant operating and investing noncash items of the discontinued operation. Additionally, if the discontinued operation includes a noncontrolling interest, the company must present the pretax profit or loss attributable to the parent.
Company management is required to provide various disclosures and reconciliations of items held for sale for the period in which the discontinued operation is classified and for all prior periods represented in the financial position statement. Further disclosures may be required if the company plans significant continuing involvement with a discontinued operation – or if a disposal does not qualify for discontinued operations reporting.
How do I report discontinued operations on my income statement?
On each company’s income statement, the discontinued operations are separated from ongoing operations. This allows investors to clearly distinguish what money is inflowing from current operations and what has ceased.
A company reports on multiple lines of its financial statements when they elect to shut down or sell a component of the business. This is critical, as the component still generates a gain or loss in the current accounting period. Therefore, the total gain or loss from the discontinued operations is reported, followed by the relevant income taxes. Seeing as many discontinued operations incur a loss, this particular tax is often a future tax benefit.
In order to discern the company’s total net income (NI), the gain or loss from discontinued operations is aggregated with that of continuing operations. Subsequently, the company separates adjustments on the discontinued and continuing operations. Adjustments may be necessary due to benefit plan obligations, contingent liabilities, or contingent contract terms.
If the buyer of a discontinued operation assumes the debt associated with the operation, any interest expense before the sale is allocated to the discontinued operations. GAAP do not allow assignment of general corporate overhead to discontinued operations.
After deducting all expenses, an investor is left with a number known as net income from continuing operations. This figure is reached by calculating the profit from continuing operations during the period covered by the income statement.
On the other hand, the net income from discontinued operations reveals the profit or loss made during the current accounting period from business lines or units that will no longer be a part of the company.
An example of including discontinued operations on the income statement is here.
What are the additional disclosure rules?
As noted above, adjustments for disposal-related amounts are separated into a disparate portion of the income statement specifically for discontinued operations. Examples of such adjustments are:
- Benefit Plan Obligations – Contingencies related to employee benefit plans, such as post-employment benefits, are settled. This type of adjustment is restricted to discontinued operations only if it occurs no later than one year following the disposal transaction.
- Contingent Liabilities – Contingencies related to liabilities associated with the disposal transaction are resolved. An example is site remediation liabilities retained by the seller.
- Contingent Terms – Contingencies related to terms under which the disposal transaction was resolved. One example is an adjustment to the initially paid price.
If you have any questions or would like additional information on how to report discontinued operations, please contact us today!
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.