Question

Problem 4-2 (Essay)

On November 1, 2016, Campbell Corporation management decided to discontinue operation of its Rocketeer Division and approved a formal plan to dispose of the division. Campbell is a successful corporation with earnings of $150 million or more before tax for each of the past five years. The Rocketeer Division, a major part of Campbell’s operations, is being discontinued because it has not contributed to this profitable performance.

The division’s main assets are the land, building, and equipment used to manufacture engine components. The land, building, and equipment had a net book value of $42 million on November 1, 2016.

Campbell’s management has entered into negotiations for a cash sale of the division for $36 million (net of costs to sell). The sale date and final disposal date of the division is expected to be July 1, 2017. Campbell Corporation has a fiscal year ending May 31. The results of operations for the Rocketeer Division for the 2016–17 fiscal year and the estimated results for June 2017 are presented below. The before-tax losses after October 31, 2016, are calculated without depreciation on the building and equipment.

	Period		Before-Tax Loss
	June 1, 2016, to October 31, 2016		$(2,500,000	)
	November 1, 2016, to May 31, 2017		(1,600,000	)
	June 1 to 30, 2017 (estimated)		(300,000	)

The Rocketeer Division will be accounted for as a discontinued operation on Campbell’s financial statements for the year ended May 31, 2017. Campbell’s tax rate is 25% on operating income and all gains and losses. Campbell prepares financial statements in accordance with IFRS.

(d)
Assume that Campbell Corporation management was debating whether the sale of the Rocketeer Division qualified for discontinued operations accounting treatment under IFRS. List specific factors or arguments that management would use to suggest that the Rocketeer Division should be treated as a discontinued operation. Why might management have a particular preference about which treatment is given? From an external user’s perspective, what relevance does the presentation of the discontinued operation have when interpreting the financial results?

Answer 1

(d) The Rocketeer Division financial results should be shown as a discontinued operation according to the following factors:

• Management has “formally” decided to dispose of the Rocketeer Division
• The division represents a separate major line of business (as noted – it is a major portion of the company’s operations). It is a separate component of the entity and is operationally distinct, where the operations, cash flows, and financial elements are clearly distinguishable from the rest of the enterprise (as evidenced by the measurement of the division losses) – thus the accountants will be able to measure the loss from operations and disposition of the assets.
• There is an active program to find a buyer (negotiations are in process)

Management could argue the following points against using discontinued operations treatment:

• Changes to the plan are possible or likely, and
• The assets are not available for immediate sale in their current state

Management would usually prefer using the discontinued operations treatment. This separates the financial results of the division from continuing operations and allows users to concentrate on continuing financial results and to assess management performance on the more profitable parts of the business. This also allows users to see the unprofitable impact of the Rocketeer Division on prior years’ results since comparative figures are presented. For a user, showing discontinued operations at the bottom of the income statement after income tax expense and with its own earnings per share information provides more information about the quality and recurrence of earnings.