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18/03/2021 09:00:06 PM

Discontinued Operations

Companies sometimes dispose of entire divisions or product lines. When these disposi­tions pertain to separately identifiable business segments, they are accorded special accounting treatment in the income statement. A component of an entity comprises operations (and cash flows) that can be clearly distinguished, operationally and for purposes of financial reporting, from the rest of the business.

Accounting for Discontinued Operations

To qualify as discontinued operations, the assets and business activities of the divested segment must be clearly distinguishable (both physically and operationally) from the assets and business activities of the remaining entity. For example, discontinuance of an entire line of products will usually qualify as a discontinued operation, but not the dis­continuance of a particular brand. Judgment is involved in deciding what constitutes a discontinued operation since it depends on the nature and scale of a company’s business-what constitutes a discontinued operation for one company may not for another. Companies also record gains or losses from discontinued operations when they sell their stake (either fully or partially) in a consolidated subsidiary.

Accounting and reporting for discontinued operations is twofold. First, the income statements for the current and prior two years are restated after excluding the effects of the discontinued operations from the line items that determine continuing income. Second, gains or losses pertaining to the discontinued operations are reported separately, net of their related tax effects, and are excluded from continuing income. Continuing income is called income before discontinued operations when discontinued operations are reported.

 

Analyzing Discontinued Operations

Analysis is futuristic and decision oriented. Therefore, for purposes of analysis, all effects of discontinued operations must be removed from current and past income. This rule applies regardless of whether the objective is determining economic or permanent income or in determining operating or non-operating income. The adjustment is straightforward for the current and past two years because companies are required to restate their income statements and report the income or loss on discontinued opera­tions separately. Such ready information does not exist for prior years. Some companies restate summary financial information, including income, for the past 10 years, which we can then use. Also, some companies report several prior years’ information about discontinued operations separately. Yet, in most cases this information is unavailable. In such situations, an analyst must be careful when conducting inter temporal analysis, such as evaluating income patterns over time. With regard to a company’s financial condition, an analyst must remove the assets and liabilities of the discontinued operations from the balance sheet (if they are not already removed). Amounts for assets and liabilities are typically provided in footnote disclosures. The cumulative gains or losses from discontinued operations should not, however, be removed from equity