Question

On 1 August 20X5, Graham Ltd. decided to discontinue the operations of its services division. The services division is not a separate corporation, but it is a major operating segment, financially and operationally. On 22 September 20X5, Graham closed a deal to sell the division to Frost Ltd. Frost will assume responsibility for the current liabilities (e.g., accounts payable and accrued liabilities) that pertain to the division. The facts pertaining to the sale are as follows:

On 31 December 20X5, the after tax net income, including the services division, was $300,000.

 

REQUIRED:

1. Give the entries to record the (a) reclassification and (b) sale of the services division.

2. Complete the 20X5 income statement, starting with income from continuing operations, after tax.

3. Explain what other disclosures and/or reclassifications are necessary in the 20X4 comparative financial statements and notes.

Answer 1

Requirement 1(a) x Reclassification and recognition of loss, 1 August 20X5:

Assets of services division, held for sale*		275,000
Current liabilities		135,000
Accumulated depreciation		167,500
Impairment loss, services division		32,500
Deferred tax liability ($32,500 × 32%)		10,400
	Assets – services division		475,000
	Current liabilities – services division held for sale		135,000
	Income tax expense ($32,500 × 32%)		10,400
* Students may be tempted to deduct $40,000 commission. However, that amount is not known on August 1.

 

Requirement 1(b) x Sale of services division, 22 September 20X5:

Cash (less $40,000 broker’s fee)		195,000
Current liabilities – services division held for sale		135,000
Income tax expense ($55,000 × 32%)		17,600
	Assets of services division, held for sale		275,000
	Gain on sale of services division		55,000
	Income tax liability		17,600

 

Requirement 2 x Partial income statement

Net earnings from continuing operations, after tax*			$266,000
Discontinued operations:
	Operating profit from services division, after tax**	$ 18,700
	Gain on sale of services division, net of tax	15,300	34,000
Net income			$ 300,000

*Verification of earnings from continuing operations after tax (not required):

Total earnings after taxes (given)	$300,000
Plus losses (minus gains) after tax:
Impairment loss ($32,500 × 68%)	22,100
Gain on sale ($55,000 × 68%)	(37,400)
** Services division operating profit ($27,500 × 68%)	(18,700)
Net earnings from continuing operations	$ 266,000

 

Requirement 3

On the 20X4 prior-year financial statements, the assets and liabilities relating to the discontinued division should be segregated from other asset and liabilities, grouped together (all assets together in a group, and all related liabilities together in a group) and reported as current assets and current liabilities of the “services division held for sale”. Also, the net earnings relating to the division should be shown in the discontinued operations section of the balance sheet.

 

Note disclosure would include:

·         a description of the facts and circumstances leading to the disposal, as well as the date of sale; and

·         the major categories of assets and liabilities involved in the sale.

 

The gain on sale and the operating earnings must also be disclosed, if those amounts are not reported separately on the income statement (as above).