Selling Part of Your Business? Rules for Reporting ‘Discontinued Operations’June 13, 2016
Reporting ‘discontinued’ operations on your income statement can be somewhat tricky and complex.
Management teams often face tough decisions regarding disposals of parts of their businesses. Whether an opportunity arises to sell a profitable division of the company, or the company determines that a disposal would make things more efficient, these disposals typically lead to discontinued operations in regard to the company’s accounting, and can also complicate financial reporting. In order to avoid such headaches, there are a few things to consider when dealing with and reporting on discontinued operations.
When does a discontinued operation occur?
Generally speaking, a discontinued operation occurs when a component of an entity is either:
- Disposed (e.g. through sale or abandonment) or
- Held for sale, meaning that a buyer is being actively sought and a deal is expected to be completed within a year.
A component of the entity is anything with a distinct set of operations and cash flows – a division, a product line or even a group of assets. The sale or disposal of the component must represent a strategic shift that has a major effect on operations and financial results to be reported in discontinued operations.
How are discontinued operations reported?
Discontinued operations are reported separately on the income statement (net of tax) and the statement of cash flows. They must be shown for all periods presented, meaning that the income statement items must be reclassified for the prior year as well, even though the component was not intended to be disposed at that time.
On the balance sheet, assets and liabilities held for sale should also be separated. The aim is to present financial statements of continuing operations that are comparable with prior and future periods.
Not sure how to report?
Additional items included with the discontinued operations
Beyond the actual operations of the disposed component as they would appear on an income statement, a few additional items are included with the discontinued operations:
- Any gain or loss associated with the transaction is shown on the face of the financials and excluded from continuing operations to avoid skewing results of the ongoing business.
- Interest expense related to debt to be assumed by a buyer is included with discontinued operations.
- Generally, an expense which will no longer be incurred going forward, as a direct result of the discontinued operations, can be included. However, be careful - GAAP prohibits allocating portions of overhead costs (which affect the entire company) to the discontinued operation.
For example, the utilities bill for a manufacturing plant cannot be partially allocated to discontinued operations which will continue producing other products.
If you continue to hold an interest in a disposed component, do you still have to report it?
Continuing interest in a disposed component does not eliminate the need for reporting discontinued operations. Often, a company can have:
- Some kind of ongoing agreement for consulting
- An earn-out agreement (See our blog: What is an Earn-Out and Do I need One When I Sell my Business?);
- Or even an equity stake in a discontinued operation sold to a buyer.
These continuing interests require disclosure; the level of disclosure is based on the nature of the continuing involvement.
While not a comprehensive list, the above items can help management prepare financial statements and perform analysis as necessary to determine what should be included with discontinued operations.
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