What are discontinued operations?
In financial accounting, discontinued operations refer to parts of a company’s core business or product line that have been divested or closed and that are reported separately from continuing operations in the income statement.
Understanding Discontinued Operations
Discontinued operations are listed separately in the income statement because it is important for investors to be able to clearly distinguish the earnings and cash flows of continuing operations from those activities that have ceased. This distinction is especially useful when companies are merging, as analyzing which assets are being sold or retired provides a clearer picture of how a company will make money in the future.
In a company’s income statement, discontinued operations are separated from continuing operations so that investors can clearly see what money is coming in from current operations versus those that have ceased.
Disclosure on income statements
When operations are discontinued, a company has several items to report in its financial statements. Although the trading component is closing, it could still generate a profit or loss in the current accounting period.
Therefore, the total gain or loss from discontinued operations is reported, followed by the corresponding income taxes. This tax is often a future tax benefit because discontinued operations often incur losses. To determine the total net income (IN) of the company, the profit or loss from discontinued operations is added to that from continuing operations.
In order not to confuse adjustments to financial statements that relate to previously reported discontinued operations, a company may classify adjustments separately in the discontinued operations section of its financial statements. Adjustments may occur due to benefit plan obligations, contingent liabilities, or contingent contractual terms.
If the buyer of a discontinued operation assumes the debt associated with the operation, any pre-sale interest expense is allocated to the discontinued operations. Generally Accepted Accounting Principles (GAAP) do not allow corporate overhead to be allocated to discontinued operations.
- Discontinued operations is an accounting term that refers to parts of a company’s core business or product line that have been divested or closed.
- Discontinued operations are reported in the income statement separately from continuing operations.
- When companies merge, understanding which assets are being sold can give a clearer idea of how a company will make money in the future.
Discontinued operations under GAAP
A company can report discontinued operations under GAAP as long as two conditions are met. First, the transaction to close the divested business will result in the removal of the divested business’s operations and cash flows from the company’s operations. Second, once it has been discontinued, the closed business must not have a significant continuing involvement with its operations. If both of these conditions are met, a company can report discontinued operations in its financial statements.
Discontinued operations under IFRS
The reporting rules in International Financial Reporting Standards (IFRS) differ slightly from GAAP. A discontinued operation must meet two criteria. First, the asset or trade component must be disposed of or declared as held for sale. Second, the component must be distinguished as a separate business that is intentionally withdrawn from operation or a subsidiary of a component that is held with the intention of selling.
Unlike GAAP reporting requirements, IFRS standards allow investments under the equity method to be classified as held for sale. In addition, under IFRS, entities can continue to participate in the discontinued operation. As with GAAP, discontinued operations are reported in a special section of the income statement.