In general, the term discontinued operations refers to the operations of a “segment of a business” which has been or is planned to be abandoned or otherwise disposed of. The term segment of a business is defined as a component of an entity whose operations encompass a separate major line of business or class of customer. A component can be a subsidiary, division, joint venture, or unconsolidated investee. However, although in theory it may seem straightforward; accountants have had difficulty interpreting these broad theories in practice.
Through this post, I am going to bring you into a closer look of the discontinued operations. Essential [and fundamental] accounting standard related to this topic are brought into a single post that I hope will bring you into an easier way to understand the concept as well as the standard comprehensively. Enjoy!
Measurement Date of Discontinued Operations
The component [discontinued operations] should be reported as discontinued during the first reporting period in which management having the requisite authority commits itself to a formal plan of disposal. This is referred to as “the measurement date”. Once the decision to dispose of the component has been made, the component’s operating results prior to the measurement date should be presented on the income statement as a separate category before Extraordinary Items.
Any financial statements for a prior period, presented for comparative purposes, should be restated to conform to this presentation.
The formal plan of disposal should include:
- an identification of the major assets to be disposed;
- the expected method of disposal;
- the expected period required to complete the disposal, which should generally be within 12 months of the plan’s adoption, (4) an estimate of the results of operations from the measurement date to the disposal date (phase-out period); and
- the estimated proceeds to be realized by disposal.
Disposal Date of Discontinued Operations
The disposal date is the closing date if a sale is contemplated. Any gain or loss on the actual disposal of the segment [combined with the operating results of the discontinued operations], should be disclosed separately on the face of the income statement or in a note. Income taxes applicable to both items should also be disclosed on the face of the income statement or in a note to the financial statements.
Examples of Discontinued Operations
APB Opinion No. 30 states that the discontinuance of a part of a segment of a business, that is the phasing out of a product line or class of service, or a shift in production or marketing emphasis or location is incidental to the evolution of an entity and, accordingly, does not qualify for treatment as a discontinued operation.
As I have said on the preface; although in theory the criteria may seem straightforward, accountants have had difficulty interpreting these broad criteria in practice. But let’s overview these criteria further. Read on…
Recognizing this difficulty, the American Institute of Certified Public Accountants (AICPA) issued “Accounting Interpretation of APB Opinion No. 30” in November 1973 to provide guidance on the classifications found in Opinion No. 30. The interpretations provide the following examples as situations that qualify as discontinued operations:
- The sale of a major division that represents an entity’s only activity in a specific industry; the assets and results of operations of the division are clearly separable.
- The sale by a meat-packing company of a 25 percent interest in a professional ball club that they had accounted for under the equity method.
- The sale by a communications company of all its radio stations (constituting 30 percent of total consolidated revenues). The remaining activities are television stations and a publishing company. The assets and results of operations of the radio station are clearly separable both physically and operationally.
- The disposal by a food distributor of one of its two food divisions, which use significantly different channels of distribution. One division sells food wholesale primarily to supermarket chains, and the other division sells food through its chain of fast food restaurants, some of which are franchised and some of which are company-owned. Although both divisions are in the business of distribution of food, the sale of food through fast food outlets is vastly different in nature from wholesaling food to supermarket chains. Thus, by having two major classes of customers, the company has two segments of business.
Recording Discontinued Operations
The method of recording the discontinuation or disposition of a business segment is determined by whether there is a gain or a loss. A gain should be recognized when it is realized, usually at the disposal date. Losses, on the other hand, should be anticipated and recorded at the measurement date. The gain or loss on disposal is calculated at the measurement date, using estimates of the results of operations during the phase-out period.
The APB was concerned that the gain or loss on disposal could conceal normal write-downs on a going-concern basis, for example, inventory or receivable adjustments. Thus it stated that such write-downs should be included in results of operations prior to the measurement date unless clearly and directly associated with the disposal decision. The Emerging Issues Task Force (EITF) in Issue No. 85-36, “Discontinued Operations with Expected Gain and Interim Operating Losses”, considered the need for clarification of APB Opinion No. 30 and the related interpretations thereof in accounting for any expected losses from the measurement date to the disposal date when a gain on disposal was expected.
The Task Force consensus stated that estimated losses from operations should only be deferred until the disposal date if there is reasonable assurance that a net gain will be realized. The Task Force also reached consensus on two underlying issues. The first consensus applied the previous consensus to sales that do not meet the criteria of a segment. Second, it stated that all multiple disposals of segments under the same formal plan should be reported as a combined amount. However, if the criteria for discontinued segments are not met, these disposals, such as a portion of a line of business, should not be combined.
Accounting for Discontinued Operations Subsequently Retained
The EITF, “Accounting for Discontinued Operations Subsequently Retained” in Issue 90-16, considered a situation in which a company decides to dispose of a segment of its business in accordance with APB No. 30. In accruing the loss on disposition of the segment, the company wrote down assets to net realizable value. The assets would not have been treated as impaired and no loss would have been accrued if the company had not decided to discontinue the operations of that segment. In the next period, management decided to retain the segment.
The following accounting issues are present:
- Issue 1—Should any of the accrued losses on writing down the segment to net realizable value be reversed now that the segment is no longer being discontinued?
- Issue 2—Should the financial statements of the prior period be restated or reclassified as a result of the subsequent decision to retain the business segment?
The EITF reached a consensus that the remaining estimated accrued loss should be reversed in the period the company decides to retain the business segment. The portion of the prior period loss related to actual operations of the business in the prior period should not be reversed. There is to be continual evaluation of the business segment following impairment guidelines as practiced by the company, and any individual asset impairments are to be classified as continuing operations.
The EITF concluded that the reversal is not an error and the prior periods should not be restated. However, the business segment’s results of operations reported in prior periods should be reclassified from discontinued to continuing operations. The remaining estimated accrued loss should continue to be reported as discontinued segments in the prior period financial statement. In the current reporting period, continuing operations should include current period operating results of the segment. The remaining un-accrued loss should be reversed as part of discontinued operations.
For those filing with the Securities and Exchange Commission [SEC], the observer called for the following six additional disclosures:
- Reason for reversal of decision
- Total segment assets, liabilities, revenues, and operating results of the segment previously reported as discontinued
- Amount of loss recognized when the segment was recorded at net realizable value and basis for calculation
- Disclosure of impairment losses recorded by business segment (Losses due to asset impairment must be classified before income from continuing operations).
- Disclosure of amount and components of amounts of accrued losses subsequently reversed
- Management discussion and analysis (MD&A)
Allocation Of Costs And Expenses
The EITF also considered the questions of whether interest or general corporate overhead could be allocated to a discontinued operation. The Task Force reached a consensus that general corporate overhead may not be allocated. Interest may be allocated, although it is not required to be allocated. If interest is allocated, the calculation of the method to be used is described in EITF Issue No. 87-24, “Allocation of Interest to Discontinued Operations.”
The SEC observer indicated that public companies must clearly disclose the accounting policy to allocate interest, the method used to determine the amount of interest allocated and the amount allocated to pre-measurement date, and estimated predisposal date periods.
Disclosure of Discontinued Operations
Certain disclosures are required for the periods from the measurement date to the disposal date:
- Identification of the discontinued segment
- Expected disposal date and manner of disposal (sale or abandonment)
- Remaining assets and liabilities of segment at the balance sheet date
- Results of operations and any proceeds from disposal of the segment during the period from the measurement date to the balance sheet date (and a comparison with any prior estimates
- Disclosure of per share data, although not separately required for discontinued operations, is commonly given on the face of the income statement or in the notes.
In the Staff Accounting Bulletin (SAB) 93, “Accounting and Disclosure Regarding Discontinued Operations”, the SEC considered seven clarification issues with respect to discontinued operations:
Method of Disposal Not Determined – The SEC considered the circumstances where an entity adopts and announces a plan to discontinue a segment but has not determined the manner by which certain material operations will be discontinued (sale, spin-off, or liquidation). The SAB indicates that in such circumstances paragraph 14 of APB 30 has not been complied with since the “expected method of disposal … and the expected proceeds or salvage to be realized by disposal” is not known.
Plan of Disposal Requiring More than One Year – Where there are multiple sales of assets or divisions contemplated under a plan of disposal, all such sales should occur within one year. The SEC believes that to qualify under paragraphs 15–17 of APB 30 for classification outside of continuing operations, the plan of disposal must contemplate the consummation of the disposal of all portions of the business segment within 12 months of the plan’s adoption. The staff of the SEC believes that the accounting estimates needed under accounting for a discontinued operation cannot be developed with sufficient reliability if projections beyond 12 months from the plan’s adoption are required.
Accounting for Abandonment of a Business Segment – If a company adopts a plan of discontinuance but is required by contract or regulation to continue to provide services for periods remaining under existing contracts which may exceed one year, discontinued operation accounting may be appropriate. The staff will not object if discontinued accounting is used when the company will not accept new business (other than it is required to do under existing contracts or regulations) within 12 months of a plan’s adoption. The operating results of the segment through final termination must be estimable with reasonably accuracy.
Disposal of Operation with Significant Interest Retained – When a company sells a majority interest in a segment but retains an interest suf?cient to require equity accounting under APB 18, discontinued accounting is not appropriate. The staff believes that the transaction should be accounted for as a disposal of a portion of a line of business.
Classification and Disclosure of Contingencies Relating to Discontinued Operations – If a company had appropriately accounted for the disposal of a segment in a previous year, but had continuing obligations under the contract so that estimates were required, revisions of those estimates are to be classified as discontinued operations as indicated in paragraph 25 of APB 30. However, the staff believes that any changes in the carrying value of assets received in the exchange as consideration should be classified within continuing operations.
Accounting for Subsidiaries That Management Intends to Sell – When a company plans to sell a segment but discontinued accounting is not yet appropriate, the company cannot deconsolidate the segment under the view that control is temporary under SFAS 94. The staff believes that the concept of control as indicated in SFAS 94 does not encompass planned sales. The concept of temporary control is intended to encompass events that are outside the control of the entity.
Accounting for the Spin-Off of a Subsidiary – If a company spins off a subsidiary, it should not ordinarily account for the transaction by restating previous financial statements as a change in entity under paragraph 30 of APB 20, as if the company never had an investment in the subsidiary. In limited circumstances involving an initial public offering (IPO), the staff has not objected to such accounting if the spin-off was completed prior to the effectiveness of the offering and certain conditions are met.