What Are Discontinued Operations?

In financial accounting, discontinued operations refer to parts of a company’s core business or product line that have been divested or shut down, and which are reported separately from continuing operations on the income statement.

Understanding Discontinued Operations

Discontinued operations are listed separately on the income statement because it's important that investors can clearly distinguish the profits and cash flows from continuing operations from those activities that have ceased.

This distinction is especially useful when companies merge, as parsing out which assets are being divested or folded gives a clearer picture of how a company will make money in the future.

Disclosure on Income Statements

When operations are discontinued, a company has multiple line items to report on its financial statements. Although the business component is being shut down, it still could generate a gain or loss in the current accounting period.

The total gain or loss from the discontinued operations is thus reported, followed by the relevant income taxes. This tax is often a future tax benefit because discontinued operations often incur losses. To determine the company's total net income (NI), the gain or loss from discontinued operations is aggregated with that of continuing operations.

So as 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 financials. Adjustments may occur because of benefit plan obligations, contingent liabilities, or contingent contract terms.

If the buyer of a discontinued operation assumes the debt associated with the operation, any interest expense before the sale is allocated to discontinued operations. Generally accepted accounting principles (GAAP) do not allow general corporate overhead to be allocated to discontinued operations.

Discontinued Operations Under GAAP

A company may report discontinued operations under GAAP as long as two conditions are met:

• First, the transaction to shut down the divested business will result in eliminating the operations and cash flows of the divested business from company operations.
• Second, once it has been discontinued, the closed business must have no significant ongoing involvement with its operations. If these two conditions are met, then a company may report discontinued operations on its financial statements.

Discontinued Operations Under IFRS

The reporting rules under international financial reporting standards (IFRS) differ slightly from GAAP. A discontinued operation must meet two criteria:

• First, the asset or business component must be disposed of or reported as being held for sale.
• Second, the component must be distinguishable as a separate business that is being removed from operation intentionally or a subsidiary of a component being held with the intent to sell.

Unlike GAAP reporting requirements, IFRS rules permit equity method investments to be classified as held for sale. Moreover, under IFRS, entities may continue involvement with the discontinued operation. As with GAAP, discontinued operations are reported in a special section of the income statement.