Discontinued Operations

Discontinued operations refer to the former core part of a firm that was either held for sale or sold off and is no longer functional due to merger or wear out, or divestiture. In financial accounting, it is important to list in the desired financial report, i.e., a firm's income statement, for compliance with regulatory standards and to present the true picture of a firm's profitability to the stakeholders.

During mergers, it becomes an integral part of the firm's financial statements to clear the confusion over the status of unused operational functions or assets. In addition, it is useful in reselling an acquired subsidiary of a firm.

• The financial accounting term discontinued operations refer to those parts of core functions of a firm that they list for held for sale or already sold given a merger, worn out, or sold off.
• IFRS and GAAP make it mandatory to reflect the ceased operations in the income statement.
• Accounts record it at the bottom of the income tax statement in a separate line of ceased operations.
• When companies merge, it is useful for investors to know the exact profitability of a firm. Firms use it to resell any acquired subsidiary.

Discontinued operations mean recording the disposal of a functional department, product line, subsidiary, or machinery that is no longer used or held for sale on financial statements. Accountants mark any component, department, or subsidiary as discontinued when firms completely terminate them from the proceedings and undertakings and assume they safely for holding or sale. 

A company undergoes many changes through the production lifecycle and the entire duration of existence. As a result, they add many new aspects and remove or sell off old parts of the organization like machinery, subsidiary, or department. Companies do it because, with time, old parts or machinery get worn out, subsidiaries become loss-making, and the business environment changes to new dimensions. Hence, such conditions will lead to either selling off, being held for sale or being discontinued from the firm's records. Therefore, accountants must record and reflect all such discontinuation in the financial statements. 

Components like 'held for sale' are available for immediate selling and have higher chances of getting sold. Therefore, one can understand it as the disposable item being classified as a disposal group held for immediate sale. The selling of a major division of a company under its diversified scheme comes under discontinued operation. However, planned phasing out of a product line under a product group does not constitute ceased operations. Moreover, accountants must disclose every item or division of a subsidiary listed as a ceased operation in the financial statements per the IFRS and other regulatory standards.

Discontinued operations are listed distinctly from continuous undertakings on financial reports. As a result, a firm has to report multiple line items on its income statement so that investors or analysts easily distinguish the cashflows and profits from the ceased activity's continuing operations. In addition, it is useful for them to analyze how the company will earn in the future if they merge. 

A current accounting period records gain or loss that the business components generate even after shut down. Then it records relevant income tax. As discontinued operations often incur a loss, calculating this tax is significant to avail future tax benefits. Gains and losses from ceased and continuing operations determine a company's total net income (NI).

As per discontinued operations, IFRS paragraph 3 of IFRS 5 - Non-current Assets Held for Sale and Discontinued Operations, every firm has to disclose all the assets under the discontinued operations income statement, which they issued in march 2004. Companies must report all the profits and losses following the appropriate income taxes. It always amounts to future tax benefits as the discontinued enterprise ultimately incurs losses. Continuing operations collect the total gain or loss from discontinued operations.

A firm's financial statement section reflects the discontinued affairs entries. Generally accepted accounting principles (GAAP) mandate the separation of general corporate overhead and ceased operations. 

Hence, accountants report discontinued operations accounting at the lowest part of the income taxes statement. The income tax statement is necessary to separate income from discontinued operations and continued undertakings to prevent the investors from assuming that disposed items are generating any revenue, albeit only items in continued operations contribute to the income tax of the financial statement.

The following two conditions are necessary for a company to report this operation on GAAP:

1. Eliminating business cash flow and operations from the company's overall undertakings.
2. Observing the absence of significant involvement with the parent company.

Unlike international financial reporting standards (IFRS), equity investment methods are not permitted for classifications under 'held for sale.'

Let us take a closer look at the topic using the example of discontinued operations. Let a company, X Ltd., have a piece of used machinery listed for sale in its core department. After the sale, it gets $60,000 in revenue from the operation of the closed machinery. It also incurs an income tax of $11,000 as an expense. Also, it gets revenue of $50,000 from the sale of old machinery. $6000 as income tax applicable on the sale proceeds.

After this:

1. Add an income of $60,000 to the $11,000 in tax expense for getting the income from ceased operations as $49,000 net of taxes.
2. Add $49,000 profit from the sale and $-$6000 expense to obtain a gain of $43,000 revenue from the sale net of taxes.
3. Add $49,000 along with $$43,000 to get the total income net of taxes from the discontinued undertakings.

This article is a guide to What is Discontinued Operations. Here, we explain it in income statement and GAAP, along with an example. You can also go through our recommended articles on corporate finance –

• Non Operating Expenses
• Spinoff
• Restructuring