In financial accounting, discontinued operations refer to parts of a company’s core business or product line that have been divested or shut down, and which are reported separately from continuing operations on the income statement.
Key Insights
- Discontinued operations represent sections of a firm’s activities that have been sold off or permanently closed.
- They are distinctly reported on the income statement, providing clear differentiation from ongoing operations.
- This distinction is crucial during mergers for a clear view of the future money-making avenues of a company.
The Importance of Separating Discontinued Operations
Discontinued operations are listed separately on the income statement because it’s essential for investors to clearly distinguish the profits and cash flows from ongoing activities versus those that have ceased.
This clear separation is particularly useful during company mergers, as it helps investors understand which assets are being divested or phased out. On a company’s income statement, discontinued operations are segregated from continuing operations so investors can see where the revenue is flowing from current operations compared to those that are no longer active.
Disclosure on Income Statements
When operations are discontinued, a company must report multiple line items on its financial statements. Although the business component is being shut down, it may still generate a gain or loss in the current accounting period.
The total gain or loss from the discontinued operations is reported, followed by the relevant income taxes. Often, this tax is a future tax benefit due to the losses incurred from discontinued operations. To determine the company’s total net income (NI), the gain or loss from discontinued operations is combined with that of continuing operations.
To avoid confusion, a company may classify adjustments separately in the discontinued operations section of its financials. Such adjustments may include benefit plan obligations, contingent liabilities, or contingent contract terms.
If the buyer of a discontinued operation assumes the debt associated with it, any interest expense before the sale is allocated to discontinued operations. Importantly, generally accepted accounting principles (GAAP) do not allow general corporate overhead to be matched with discontinued operations.
Discontinued Operations Under GAAP
A company may report discontinued operations under GAAP if two conditions are met:
- The transaction to shut down the divested business will entirely eliminate the operations and cash flows from the divested business.
- The closed business, once discontinued, must have no significant ongoing involvement with its operations.
If these conditions are met, the company may report discontinued operations on its financial statements.
Discontinued Operations Under IFRS
The reporting rules under international financial reporting standards (IFRS) differ slightly from GAAP. A discontinued operation must meet two criteria:
- The asset or business component is to be disposed of or is held for sale.
- The component is distinguishable as a separate business that is either deliberately being removed from operation or a subsidiary held with the intent to sell.
Unlike GAAP, IFRS allows equity method investments to be classified as held for sale and permits entities to continue involvement with the discontinued operation. Similar to GAAP, discontinued operations are reported in a special section of the income statement.
Related Terms: continuing operations, divestment, cash flows, net income, GAAP, IFRS
References
- Financial Accounting Standards Board. “FASB Simplifies Discontinued Operations”.
- The International Financial Reporting Standards. “IFRS 5 Non-current Assets Held for sale and Discontinued Operations”.
