Question

Shortly define discontinued operations and explain how they are reported according to U.S. GAAP

Answer 1

What is discontinued operations?

1. Companies often cancel product lines or sell market segments. These changes result in discontinued product lines or business units.
2. Exampe: A Ltd has three product lines: 1. Garments, 2. Home furnishings and 3. Electronics. As the home furnishings line is not giving expected profit, the company decided to discontinue to produce and sell electronics. This electronics line for this company is known as discontinued operation.
3. So discontinued operations are essentially the portion of an entity that no longer functions within the main business or product lines and is reported separately on the income statement.
4. The discontinued product lines or business units can generate income till the stock produced completely gets over or for some period of time till it gets completely closed.
5. They are classified as discontinued operations within the financial statements of the company
6. To ensure external users of financial information (investors, creditors, banks etc) should not wrongly evaluate the profitability of the company’s main business.
7. Hence, the company must present a clear definition of the portion of the business that is discontinued and clear indication by the management that the discontinued operation is absolutely not the part of core business of the company.
8. This helps the creditors and investors to know what business will continue and what will end.

How are discontinued operations reported according to U.S.GAAP?

            Discontinued operations are reported under US GAAP as long as two conditions are met.

1. The component or asset or product line disposed of or sold or discontinued must be completely removed from the company operations. This indicates no future cash flows must result from this component
2. Upon the removal of the component/asset/product line, the disposing company has no continuing involvement with the item.

If these two conditions are met, discontinued operations should be reported on the income statement. Both current period and previous period operations are shown in the discontinued operations section.

The procedure for reporting discontinued operations

1. Create a separate section titled “Discontinued Operations” on the income statement. This includes
   1. The gain or loss from discontinued operations including disposal
   2. Income tax benefit or expense
   3. Tax adjusted gain or loss from discontinued operations
2. Calculate the Gain or loss from the discontinued operations
   1. Profit or loss = Sales – expenses
3. Calculate and add the gain or loss on disposal (sale) of the discontinued operation, if any:
   1. The gain or loss is the difference between the selling price and the fair market value of the discontinued operation minus costs of selling.
   2. Add this gain or loss on disposal to the gain or loss from discontinued operations
4. Calculate tax adjusted gain or loss from discontinued operations:
   1. If there is a profit, tax payable will increase.
   2. If there is a loss, the tax on the loss will decrease the tax payable to that extent.