Discontinued Operations: Its Impact on Financial Reporting
Discontinued operations refers to the shutdown of a division within a company. For accounting purposes, all the gains and losses for that division must be reported separately on the company’s income statement. This is so that these amounts can be distinguished from those of continuing operations.
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What Are Discontinued Operations?
Discontinued operations are operations a company no longer requires, and that have been shut down. An operation may be discontinued due to any number of reasons, including: the closure of a division that cannot make or sustain a profit, the sale of a company’s product line or service, or a merger with another company (resulting in redundant roles).
Income and expenses related to discontinued operations can be found on line items on a company’s income statement, below “Continuing Operations Income” and above “Net Income”.
Example of Discontinued Operations
Ned owns and runs Ned’s Networks, a company consisting of six television channels. One channel, a specialty network devoted to everything fitness, has been a money loser. In the 18 months it has been on the air, it has only generated a profit once, and it was a small one. There’s just not enough interest from the viewing public to generate the advertising revenues Ned needs. He decides, after going over the latest financial reports and meeting with his senior team, to shut down the channel.
Eight people work specifically for this channel, four in content, two in programming and two in sales. Ned is able to assign four of them to other channels that need help, but four of the staff are let go.
Ned instructs accounting to discontinue operations for this channel. This means that any income or expenses related to the channel’s operation will now fall under “Discontinued Operations” on the income statement (the one that will be generated for the same quarter he sold the station in). In Ned’s case, these amounts include sale revenues from ads, the cost of the severance packages, taxes, licensing fees, programming charges, interest expenses, etc.
Now let’s try another scenario. Ned decides to simply sell the channel.
Upon selling it, Ned instructs accounting to discontinue operations for this channel. There will still be the same income and expenses as per the first scenario, but there will also be charges related to the physical transfer of some of the channel’s equipment to the new location, as per the agreement he has in place with the buyer. These costs will also be reflected under “Discontinued Operations” on the next income statement.
What Are the GAAP Rules for Discontinued Operations?
GAAP stands for “Generally Accepted Accounting Principles”. GAAP is the accounting authority in the United States, defining accounting terms, assumptions and methods. GAAP sets policy for a wide array of topics, from assets and liabilities to foreign currency and financial statement presentation. This standardization makes it much easier for business owners, investors and government agencies to understand financial statements.
In order for an American business to classify something as a “Discontinued Operation”, GAAP has stipulated that the following must happen:
Operations and Cash Flow Must Cease
Discontinued must really mean discontinued. In Ned’s case, this means there can be no more new income after the station has been sold, and any expenses related to moving the operation to the buyer must end shortly after the sales date.
There Must Be No Future Involvement
The discontinued or sold operation must remain separate from the original business. For instance, if Ned sold the station but on the condition his sales team still sell ads for the new owner, then this transaction cannot be considered a discontinued operation.
Are Discontinued Operations Taxed?
Yes and no. A discontinued operation may still make a gain or loss in the accounting period it ceased operations in. These gains or losses must be reported. However, often a discontinued operation was operating at a loss, so there may be some money realized from taxes at tax time. Keep in mind that these losses must be weighed against those departments or components of the business that are still in operation, which are most likely generating revenue.
What Is Net Income from Discontinued Operations?
This is the profit made, if any, in the accounting period in which the operation was discontinued.