Discontinuing operations is the everyday phrasing for what US GAAP requires an entity to report as discontinued operations, which is the separate presentation of a business the entity has disposed of, or has committed to dispose of, where the disposal is significant enough to change what the rest of the entity is. Not every exit qualifies, and most do not.
The bar is deliberately high, because the presentation pulls the results of the disposed business out of continuing operations and changes the number readers use to forecast the next year.
The Test Has Two Halves, and Both Must Be Met
A disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has, or will have, a major effect on an entity’s operations and financial results, when any of the following occurs: the component or group of components meets the criteria in paragraph 205-20-45-1E to be classified as held for sale, the component or group of components is disposed of by sale, or the component or group of components is disposed of other than by sale, for example by abandonment or in a distribution to owners in a spinoff (FASB Accounting Standards Update 2014-08).
Read that as two conditions joined, not as one. The strategic shift with a major effect is the substantive test, and it has to hold. The three lettered events are the triggers, and only one of them has to occur. A disposal that hits a trigger without being a strategic shift is not a discontinued operation, and a strategic shift that has not yet reached one of the three events is not one either.
The Update names what the substantive half is reaching for. Examples of a strategic shift that has, or will have, a major effect on an entity’s operations and financial results could include a disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of an entity (FASB Accounting Standards Update 2014-08).
Every one of those examples carries the word major. Closing an underperforming office is a disposal. Exiting the region is a strategic shift.
What a Component Is
The unit being tested is defined, and the definition turns on separability rather than on size.
A component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity, and it may be a reportable segment or an operating segment, a reporting unit, a subsidiary, or an asset group (FASB Accounting Standards Update 2014-08).
That is the practical gate a client trips on first. Where the books never separated the operations and cash flows of the thing being sold, there is no component, and the question of whether the exit was a strategic shift never arises. Separability is a bookkeeping fact established while the business was running, not something reconstructed at the point of sale.
An Acquired Business Can Be One on the Day It Arrives
There is a second route in that has nothing to do with a strategic shift.
A business or nonprofit activity that, on acquisition, meets the criteria in paragraph 205-20-45-1E to be classified as held for sale also is a discontinued operation (FASB Accounting Standards Update 2014-08). An acquirer that buys a group intending to sell part of it immediately can therefore report that part as a discontinued operation without ever running the strategic shift analysis on it.
Where the Results Land
On a filed income statement the line has a caption of its own, sitting below income or loss from continuing operations, and the full order of the captions is set out in net income.
The classification also reaches the per-share disclosures, because income from continuing operations is the control number that decides whether potential common shares are dilutive, which is worked through in diluted earnings per share.
The Disposal That Does Not Qualify Still Gets Disclosed
Failing the test is not the end of the reporting.
For a disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation, the required disclosures include the pretax profit or loss attributable to that component for the period in which it is disposed of or is classified as held for sale, and, where the component includes a noncontrolling interest, the pretax profit or loss attributable to the parent for that period (FASB Accounting Standards Update 2014-08).
Where the entity does keep a foot in the door, more is required. The disclosures about an entity’s significant continuing involvement with a discontinued operation include the amount of any cash inflows or outflows from or to the discontinued operation following its disposal, and information about a discontinued operation in which the entity retains an equity method investment after the disposal transaction. Those disclosures run until the results of that operation are no longer presented separately as discontinued operations in the statement where net income is reported (FASB Accounting Standards Update 2014-08).
What It Is Confused With
- Any business closure. Shutting a branch, dropping a product or ending a client relationship is an operating decision. It becomes a discontinued operation only where a component was disposed of and the disposal was a strategic shift with a major effect.
- A discontinued product line. A line of business qualifies where it is major and separable. The word line does the least work in that sentence.
- A restructuring charge. A restructuring runs inside continuing operations. A discontinued operation is removed from continuing operations, which is why the two look nothing alike on the face of the statement.
- An impairment. A write-down measures a carrying amount, and it happens whether or not anything is being disposed of, as set out in impairment losses.
Common Questions
A disposal of a component, or a group of components, that represents a strategic shift with a major effect on the entity’s operations and financial results, once the component has been classified as held for sale, disposed of by sale, or disposed of other than by sale. A business or nonprofit activity that meets the held-for-sale criteria on acquisition also qualifies.
They are the same subject. Discontinued operations is the term US GAAP uses, and it is the caption a filed income statement carries.
Usually not. The Update’s own examples of a qualifying strategic shift are a major geographical area, a major line of business, a major equity method investment or other major parts of an entity. A small division rarely changes what the rest of the entity is.
Then it is not a component. The definition requires operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity, and a ledger that never made that split cannot produce the evidence after the fact.
Accountably places trained offshore accountants inside US CPA and EA firms, and a firm can grade a real block of its own disposal and classification work through a trial task before any client file moves.
