Question

1. Discontinued Operations

In the codification, locate the requirements for exit or disposal cost obligations. Indicate the codification reference that addresses initial measurement of these costs. Write up a one paragraph summary of the requirements. This should paraphrase the requirements and not be a copy and paste job. In the codification, locate the requirements for the disclosure requirements related to discontinued operations. List these requirements.

2. Related Party Transactions

In the codification, locate the requirements for related party disclosures. Indicate the codification reference that addresses these disclosures. Write up a one paragraph summary of the requirements. This should paraphrase the requirements and not be a copy and paste job.

Answer 1

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

International financial reporting standards (IFRS) reporting rules 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.

For a company, a discontinued operation could result from structural changes such as a shift in business models, sale of equipment, scrapping of product lines, and more. A company needs to follow strict accounting rules to disclose all crucial details regarding ceased operations. The company must also disclose its impact (if any) on the financial statements.

Example

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Financial Accounting

Discontinued Operations – Meaning, Disclosure And More

Discontinued Operations are that part or portion of a company’s core product that no longer functions. Also, these parts are either held for sale or are already sold. For accounting purposes, a company reports these parts separately from the continuing operations on the income statement.

Table of Contents

• 1 Disclosure of Discontinued Operations
• 2 Importance of Disclosure
• 3 Disclosure on Income Statement
• 4 GAAP Treatment of Discontinued Operation
• 5 Example (under GAAP)
• 6 Format
• 7 Adjustments to Discontinued Operations

DISCLOSURE OF DISCONTINUED OPERATIONS

For a company, a discontinued operation could result from structural changes such as a shift in business models, sale of equipment, scrapping of product lines, and more. A company needs to follow strict accounting rules to disclose all crucial details regarding ceased operations. The company must also disclose its impact (if any) on the financial statements.

It does not mean that discontinued operations may not generate any profits for a business. In fact, in cases where the company is in the process of selling a part, such operations continue to generate profits. Still, the company must classify them as discontinued operations in the financial statements.

IMPORTANCE OF DISCLOSURE

Moreover, a company must provide a clear definition of the operation (or operations) that is discontinued. Also, the management must clearly indicate that the discontinued operation is no longer part of the core operations.

Such classification and information ensure that the external users get an accurate picture of the company’s continued operations. Additionally, the company must also disclose any profit or loss from the sale of a discontinued operation.

The distinction for discontinued operation also becomes very useful at the time of the merger. Such classification gives a clear picture of the company’s potential cash flows.

DISCLOSURE ON INCOME STATEMENT

When a company discontinues operations, it has to report several items on the financial statements. Also, it is possible; the discontinued operation generates some revenue in the current year in which the company shuts it down or sells it. Therefore, a company must calculate the gain or loss from operations, including the applicable income tax.

Such income tax is mostly a future benefit as discontinued operation usually leads to losses. Now, when the company calculates its total net income, this gain or loss from the discontinued operation must be included.

GAAP TREATMENT OF DISCONTINUED OPERATION

GAAP allows a company to report a discontinued operation on the financial statements if two conditions are met. First, the part that the company plans to divest should result in eliminating the cash flows. Second, after the company divests the part, it must not have any significant involvement with the operations.

Under IFRS (International financial reporting standards), the criteria are slightly different. IFRS also lays down two criteria. First, the company must dispose of or report it as being held for sale. Second, the asset or part that the company wants to remove must be distinguishable as a separate business.

Moreover, IFRS allows the equity method investments to be classified as held for sale. Also, under IFRS, the discontinued operation may continue involvement with operations.

EXAMPLE (UNDER GAAP)

The below scenarios will help you to understand discontinued operations better;

• A company XYZ has several products under various different product lines. XYZ tracks the cash flows for the product lines, but not for each product. Now, if it plans to cease one of its products, then it must not classify the operations related to a single product as a discontinued operation as there is no way to track cash flows.
• Now XYZ plans to scrap one full product line. Since the company tracks cash flows for the product lines, it must classify it as a discontinued operation.
• XYZ also runs retail stores. It sells one store and agrees to supply the products to the buyer of the store. In this case, XYZ will continue to get the majority of cash flows from the same store. So, even though there is a change in the ownership, XYZ shouldn’t classify it as a discontinued operation.
• Suppose XYZ sells a few product lines. The sale agreement states that the buyer will pay XYZ a 5% royalty from the sale coming from these product lines for the next five years. In this case, XYZ will not have any continuing operational involvement in the product lines that it sold. So, the cash flows or the royalty is indirect, and therefore, it must classify the product lines as discontinued operations.

Related party Disclosures

A related party is a person or an entity that is related to the reporting entity:

• A person or a close member of that person’s family is related to a reporting entity if that person has control, joint control, or significant influence over the entity or is a member of its key management personnel.
• An entity is related to a reporting entity if, among other circumstances, it is a parent, subsidiary, fellow subsidiary, associate, or joint venture of the reporting entity, or it is controlled, jointly controlled, or significantly influenced or managed by a person who is a related party

The objective of IAS 24 is to ensure that an entity's financial statements contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances with such parties.