When a company decides to halt a segment of its operations, the financial implications are significant. Discontinued operations can arise from various strategic decisions such as divestitures, closures, or spin-offs. Understanding how these changes affect financial reporting is crucial for stakeholders.
This topic holds importance because it directly influences a company’s reported earnings and overall financial health. Proper accounting for discontinued operations ensures transparency and accuracy in financial statements, which is essential for investors, regulators, and management alike.
Key Criteria for Discontinued Operations
Determining whether a component of a business qualifies as a discontinued operation involves specific criteria. The Financial Accounting Standards Board (FASB) outlines that a component must represent a strategic shift that has or will have a major effect on the entity’s operations and financial results. Examples include the disposal of a major line of business or a major geographical area.
A component must also be part of a plan to dispose of the segment, and it typically must meet “held for sale” criteria (for example, being available for immediate sale in its present condition and marketed at a reasonable price). This ensures the segment is genuinely intended for disposal and not merely being restructured or temporarily halted.
Additionally, once a disposal group meets the “held for sale” criteria, it is measured at the lower of its carrying amount or fair value less costs to sell, which aligns the reported amounts with expected proceeds from the sale.
Financial Reporting Requirements
When a company identifies a component as a discontinued operation, it must segregate the results of discontinued operations from those of continuing operations.
In the income statement, companies present a single amount for discontinued operations on the face of the statement, consisting of the after‑tax results of the discontinued operation and the gain or loss on disposal (or on classification as held for sale), with major line items for the discontinued operation disclosed either on the face of the statement or in the notes. 1PDF4PRO. Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (ASU 2014‑08)
Furthermore, the balance sheet must reflect the assets and liabilities of the disposal group separately when they are classified as held for sale.
In the cash flow statement, the cash flows attributable to discontinued operations should also be reported separately (either on the face of the statement or in the notes), allowing users to assess the cash-generating ability of the continuing operations on a standalone basis.
Impact on Financial Statements
The classification of a component as a discontinued operation has immediate effects on the income statement, where the discontinued results are isolated from continuing operations. This separation clarifies ongoing performance and highlights the financial impact of the disposal.
On the balance sheet, assets and liabilities associated with the disposal group are reclassified as “held for sale” and measured at the lower of carrying amount or fair value less costs to sell. This can affect key ratios such as liquidity and leverage, influencing how stakeholders view financial position and risk.
The cash flow statement isolates the cash flows of the discontinued component. By separating these cash flows, users can evaluate the sustainability of cash generation from operations that will remain.
Disclosure Requirements
When a company classifies a component as a discontinued operation, it must provide clear disclosures that describe the nature of the discontinued operation, the reasons for the classification, and the expected timing of the disposal.
Companies also disclose the carrying amounts of major classes of assets and liabilities included in the disposal group. This detail helps users understand what is leaving the balance sheet and the potential effects on future operations.
Finally, companies should disclose any expected gains or losses from the disposal and significant costs directly related to the sale (for example, severance, contract termination, or legal fees), so users are not surprised by post‑classification adjustments when the sale closes.
Accounting Treatment
The accounting treatment for discontinued operations ensures measurement reflects expected sale proceeds. Upon classification as held for sale, the disposal group is measured at the lower of carrying amount or fair value less costs to sell, and recognized losses are recorded when identified.
Once a disposal group is classified as held for sale, companies cease recognizing depreciation and amortization on the long‑lived assets in that group because those assets are expected to be recovered through sale rather than use. 2Deloitte Accounting Research Tool (DART). 3.5 Measuring the Carrying Value of a Disposal Group Upon Classification as Held for Sale
Any gain or loss on disposal (or loss on classification as held for sale) is recognized in the period it occurs, and the results of the discontinued operation are presented separately from continuing operations so users can evaluate ongoing performance independently.