Understanding Discontinued Operations Accounting under U.S. GAAP

Key Considerations

In the ever-changing world we live in, often times, business find themselves being spread thin, sharing attention, time and resources among multiple divisions or business segments, and not exceling at any of them. Because of this, companies may choose to undergo strategic changes, such as selling or discontinuing a specific segment or division of the operations. These strategic decisions are not made lightly, and can have a major impact on the operational dynamics of a company. As with most things, these decisions may also trigger specific accounting treatment, when the company issues financial statements in accordance with U.S. GAAP. Discontinued operations accounting is a complex area of GAAP that demands attention and meticulous handling.

Let’s delve into the key considerations surrounding discontinued operations accounting under U.S. GAAP.

Definition of Discontinued Operations:

According to U.S. GAAP, a discontinued operation refers to a component of an entity that has been disposed of or is classified as held for sale. A component of an entity can be an operating segment, a reportable segment, a subsidiary, or an asset group.

Criteria for Classification:

To be classified as a discontinued operation, a disposal or sale must first be determined to represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results, Once determined, the operations must meet other specific criteria outlined in Accounting Standards Codification (ASC) 205-20. These criteria typically include:

• Disposal Plan: There must be a formalized plan for disposal, including a commitment to the plan by the company's management.
• Availability for Immediate Sale: The asset (or group of assets) must be available for immediate sale in its present condition, subject only to terms that are usual and customary for sales of such assets.
• Active Search: An active program to locate buyers or other actions required to complete the plan to sell the entity must be initiated.
• Likelihood of Completion: The sale is probable and expected to be completed within one year from the date of classification as held for sale.
• Unlikely to Change: The actions taken by the Company to complete the plan to sell indicate it is unlikely that significant changes to the plan will occur.

Measurement and Reporting:

Once a component is classified as discontinued, it needs to be measured and reported separately in the financial statements. Here are some key points:

• Measurement: The assets and liabilities of the discontinued operation should be measured at the lower of carrying amount or fair value less cost to sell. This means any impairment losses should be recognized prior to its classification as discontinued.
• Presentation: For all periods presented in the Company’s financial statements (typically 2 years for non-public companies and three year for some public filers) the results of discontinued operations should be reported as a separate line item in the balance sheet and income statement, net of tax. Additionally, any income or loss from the sale of the discontinued operation should be reported separately in the income statement as well.
• Gain or Loss on Disposal: A gain or loss on the disposal is not recorded until the period in which the sale occurs.

Disclosures:

Users of GAAP financial statements know that disclosure is paramount to the usability of the Company’s financial statements. Upon determining that the Company has discontinued operations, certain footnote disclosures are required to enable to user of the financial statements to understand the impact of the decision. These disclosures include:

• Description of the Discontinued Operation: A detailed description of the discontinued operation, including the major classes of assets and liabilities held for sale.
• Financial Impact: Disclose the pre-tax profit or loss of the discontinued operation, as well as the income tax expense attributable to it.
• Cash Flows: Provide information about the cash flows attributable to the discontinued operation, both operating and investing.
• Reasons for Disposal: Explain the reasons for the disposal and its impact on the company’s operations and financial position.

Conclusion:

In conclusion, discontinued operations accounting under U.S. GAAP involves several intricate considerations, ranging from initial classification and separating the results of the discontinued operations from those of the continuing operation to subsequent measurement and reporting. Adherence to these standards ensures transparency and comparability in financial reporting, providing stakeholders with a clear understanding of the company’s performance and strategic decisions.

As businesses continue to evolve, a comprehensive understanding of discontinued operations accounting remains essential for financial professionals and investors alike.