What are discontinued activities?
In financial accounting, discontinued operations refer to parts of a company’s core business or product line that have been sold or closed and which are presented separately from continuing operations in the income statement.
Understanding abandoned operations
Discontinued operations are listed separately in the income statement as it is important for investors to be able to clearly distinguish profits and cash flows from continuing operations from discontinued operations. This distinction is particularly useful when companies merge, because the analysis of assets that are sold or folded gives a clearer picture of how a company will make money in the future.
In a company’s income statement, discontinued operations are separated from continuing operations so that investors can see clearly what the cash flows from current operations are compared to those that have stopped.
Disclosure of income statements
When activities are interrupted, a company has several stations to report on its financial statements. Although the commercial component is being closed, it could still generate a gain or a loss during the current accounting period.
The total gain or loss of the discontinued operations is thus declared, followed by the corresponding income taxes. This tax is often a future tax benefit because discontinued operations often suffer losses. To determine the total net profit (NI) of the company, the gain or loss of discontinued operations is aggregated to that of continuing operations.
In order not to confuse adjustments to the financial statements that relate to previously reported discontinued operations, a company may classify the adjustments separately in the discontinued operations section of its financial statements. Adjustments may occur due to obligations under the employee benefit plan, contingent liabilities or contingent contractual conditions.
If the buyer of an abandoned activity assumes the debt associated with the transaction, any interest charge before the sale is allocated to the abandoned activities. Generally accepted accounting principles (GAAP) do not allow overheads to be allocated to discontinued operations.
Key points to remember
- Discontinued operations is an accounting term that refers to parts of a company’s main business or product line that have been sold or closed.
- Discontinued operations are presented in the income statement separately from continuing operations.
- When companies merge, understanding which assets are sold can give a clearer picture of how a company will make money in the future.
Discontinued operations under GAAP
A company can report discontinued operations under GAAP as long as two conditions are met. First, the transaction to close the divested business will eliminate the business and cash flows of the divested business from the business of the company. Second, once it has been abandoned, the closed business should no longer be significantly involved in its operations. If these two conditions are met, an enterprise can declare discontinued operations in its financial statements.
Discontinued operations under IFRS
The presentation rules of International Financial Reporting Standards (IFRS) differ slightly from GAAP. An abandoned activity must meet two criteria. First, the asset or commercial component must be sold or declared to be held for sale. Second, the component must be distinguishable as a separate business that is intentionally withdrawn from operation or as a subsidiary of a component held for the purpose of selling.
Unlike GAAP reporting requirements, IFRS rules allow investments to be classified using the equity method as held for sale. In addition, under IFRS, entities can continue to participate in the discontinued activity. As with GAAP, discontinued operations are presented in a special section of the income statement.