Accounting & Audit Alert- Reporting discontinued operations
Financial reporting generally focuses on the results of continuing operations. But sometimes businesses sell (or retire) a product line, asset group or another component. In certain situations, such a disposal should be reported as a discontinued operation under U.S. Generally Accepted Accounting Principles (GAAP). Starting in 2015, the rules changed, limiting the scope of transactions that must comply with the complex rules for discontinued operations.
A component comprises operations and cash flows that can be clearly distinguished, both operationally and for financial reporting purposes, from the rest of the company. It can be a reportable segment or an operating segment, a reporting unit, a subsidiary or an asset group. Under previous guidance, three requirements were needed for a transaction to be classified as discontinued operations:
- The component had been disposed of or was classified as “held for sale.”
- The operations and cash flows of the component had been (or would have been) eliminated from the ongoing operations of the entity as a result of the disposal transaction.
- The entity didn’t have any significant continuing involvement in the operations of the component after the disposal transaction.
Some stakeholders felt that too many disposals, including routine disposals of small groups of assets, qualified for discontinued operations presentation under the previous guidance. They also found the definition of discontinued operations to be unnecessarily complex and difficult to apply.
So, the Financial Accounting Standards Board updated the rules. Accounting Standards Update No. 2014-08 eliminated the second and third conditions. Instead, disposal of a component (including business activities) must be reported in discontinued operations only if the disposal represents a “strategic shift” that has or will have a major effect on the company’s operations and financial results. Examples of a qualifying strategic major shift include disposal of a major geographic area, a line of business or an equity method investment.
When such a strategic shift occurs, a company must present, for each comparative period, the assets and liabilities of a disposal group that includes a discontinued operation separately in the asset and liability sections of the balance sheet.
Although fewer transactions qualify as discontinued operations than qualified under the previous rules, those that do qualify require expanded disclosures for the periods in which the operating results of the discontinued operation are presented in the income statement. For example, companies must disclose the major classes of line items constituting the pretax profit or loss of the discontinued operation. Examples of major line-item classes include revenue, cost of sales, depreciation and amortization, and interest expense.
In addition, companies must disclose either 1) the total operating and investing cash flows of the discontinued operation, or 2) the depreciation, amortization, capital expenditures, and significant operating and investing noncash items of the discontinued operation. And, if the discontinued operation includes a noncontrolling interest, the company must provide the pretax profit or loss attributable to the parent.
Management also must provide various disclosures and reconciliations of items held for sale for the period in which the discontinued operation is so classified and for all prior periods presented in the statement of financial position. Additional disclosures may be required if the company plans significant continuing involvement with a discontinued operation — or if a disposal doesn’t qualify for discontinued operations reporting.
Most companies don’t report discontinued operations every year, so you might not have experience applying the current guidance for reporting these transactions. But we do. Our staff can help determine the appropriate treatment for your disposal and compose the requisite footnote disclosures. Contact us for more information.