Resolved: Discontinued Operations
Hi,
If discontinued operations are "a portion of the entity that no longer functions within it core business", how is it that they still report revenue and net income, although separately? In the example of a telcom company no longer providing internet, how would the net income from something no longer offered (internet) be anything other than zero?
Thanks in advance
5 answers ( 3 marked as helpful)
Hi,
thank you for reaching out! This is a good question!
The concept of discontinued operations can be a bit confusing, especially when thinking about how revenue and net income are reported after the operations have ceased.
Here’s how it works:
When a company decides to discontinue a portion of its business, like a telecom company stopping its internet service offerings, it does not necessarily mean that the financial activities of that segment stop immediately.
When a company decides to discontinue a portion of its business, like a telecom company stopping its internet service offerings, it does not necessarily mean that the financial activities of that segment stop immediately.
Instead, the process of discontinuing the operation typically involves a few steps:
Decision to Discontinue: The company makes a formal decision to stop a certain operation.
Selling or Phasing Out: The company might either sell the assets associated with that operation or phase out the operations over time.
Reporting Period: During the time when the operation is being phased out or sold, it can still generate revenue and incur expenses, which will be reported separately as discontinued operations.
Decision to Discontinue: The company makes a formal decision to stop a certain operation.
Selling or Phasing Out: The company might either sell the assets associated with that operation or phase out the operations over time.
Reporting Period: During the time when the operation is being phased out or sold, it can still generate revenue and incur expenses, which will be reported separately as discontinued operations.
Even after the decision to discontinue an operation is made, the company may still be in the process of winding down that operation or may be waiting to complete a sale of the related assets.
In your example of a telecom company discontinuing its internet service, if the company decides to stop providing internet services on January 1, it might take several months or even a year to completely wind down the operations, during which it could still serve customers, generate revenue, and incur expenses. The financial results from those activities will be reported as discontinued operations until the process is complete.
In your example of a telecom company discontinuing its internet service, if the company decides to stop providing internet services on January 1, it might take several months or even a year to completely wind down the operations, during which it could still serve customers, generate revenue, and incur expenses. The financial results from those activities will be reported as discontinued operations until the process is complete.
In summary, discontinued operations can still report revenue and net income because the operation doesn’t cease immediately upon the decision to discontinue. There’s often a transitional period during which the business segment continues to operate, albeit with the intention of being shut down or sold off. The reported figures reflect the financial performance of that segment during this wind-down phase.
Best,
Hi Antoniya,
Thank you for the answer. Following up on the topic, does a company only need to "decide" to discontinue an operation in order for it to be reported separately or does it involve an specific process? Also is it allowed for an operation classified as "discontinued" to be reincorporated into the core business? Could this be used to "manipulate" information taken out of the financial reports?
Hope to read your thoughts on this matter.
Thanks,
Hi Jacobo,
I'm happy to have such type of discussions here, thank you for your questions!
The classification of an operation as "discontinued" in financial reporting is not merely a decision the company can make at will; it involves meeting specific criteria set by accounting standards, such as those outlined in IFRS 5 ("Non-current Assets Held for Sale and Discontinued Operations") or ASC 205-20 under U.S. GAAP.
Criteria to Qualify as Discontinued:
Criteria to Qualify as Discontinued:
- Component of an Entity: The operation must represent a separate major line of business or geographical area of operations or a subsidiary acquired exclusively with a view to resale.
- Plan for Discontinuation: The company must have a formal plan to dispose of the operation. This includes a commitment from management to sell or dispose of the component within a year.
- Active Marketing and Sale: The operation must be available for immediate sale in its present condition and must be actively marketed for sale at a price that is reasonable given its current fair value.
- Likelihood of Completion: The sale should be highly probable, with the sale expected to be completed within one year.
These criteria ensure that only operations with a genuine and imminent plan for discontinuation are classified as discontinued operations.
Once an operation is classified as discontinued, it must be reported separately in the financial statements. This involves segregating its income and expenses, gains or losses on disposal, and related tax effects from those of continuing operations. This separate reporting provides transparency to investors and other stakeholders, allowing them to see the results of the company's ongoing operations distinct from those that are being phased out.
- Plan for Discontinuation: The company must have a formal plan to dispose of the operation. This includes a commitment from management to sell or dispose of the component within a year.
- Active Marketing and Sale: The operation must be available for immediate sale in its present condition and must be actively marketed for sale at a price that is reasonable given its current fair value.
- Likelihood of Completion: The sale should be highly probable, with the sale expected to be completed within one year.
These criteria ensure that only operations with a genuine and imminent plan for discontinuation are classified as discontinued operations.
Once an operation is classified as discontinued, it must be reported separately in the financial statements. This involves segregating its income and expenses, gains or losses on disposal, and related tax effects from those of continuing operations. This separate reporting provides transparency to investors and other stakeholders, allowing them to see the results of the company's ongoing operations distinct from those that are being phased out.
Reincorporation of Discontinued Operations:
While accounting standards do not typically address the reincorporation of previously discontinued operations back into the core business in detail, such an action would be unusual and could potentially raise concerns about the company’s reporting practices. If a previously discontinued operation were reincorporated, it would require reclassification in the financial statements. The company would have to disclose this change and explain why the operation, once considered discontinued, is now part of continuing operations again.
Risk of Manipulation:
There is a potential risk that companies could manipulate their financial reporting by strategically classifying or declassifying operations as discontinued to influence financial results. For example, by classifying a poorly performing segment as discontinued, a company could remove its losses from the core business results, thereby presenting a more favorable picture of ongoing operations. However, strict accounting standards and requirements for disclosure are in place to prevent this kind of manipulation. Auditors and regulators closely scrutinize such decisions to ensure they are justified and reflect the company's actual business circumstances.
In conclusion, the classification of an operation as discontinued involves meeting specific criteria and is subject to scrutiny to ensure that the financial statements accurately reflect the company's situation. While reincorporating a discontinued operation is possible, it is uncommon and would require careful disclosure to avoid misleading stakeholders. Companies are required to provide full transparency around these decisions to prevent any manipulation of financial information.
While accounting standards do not typically address the reincorporation of previously discontinued operations back into the core business in detail, such an action would be unusual and could potentially raise concerns about the company’s reporting practices. If a previously discontinued operation were reincorporated, it would require reclassification in the financial statements. The company would have to disclose this change and explain why the operation, once considered discontinued, is now part of continuing operations again.
Risk of Manipulation:
There is a potential risk that companies could manipulate their financial reporting by strategically classifying or declassifying operations as discontinued to influence financial results. For example, by classifying a poorly performing segment as discontinued, a company could remove its losses from the core business results, thereby presenting a more favorable picture of ongoing operations. However, strict accounting standards and requirements for disclosure are in place to prevent this kind of manipulation. Auditors and regulators closely scrutinize such decisions to ensure they are justified and reflect the company's actual business circumstances.
In conclusion, the classification of an operation as discontinued involves meeting specific criteria and is subject to scrutiny to ensure that the financial statements accurately reflect the company's situation. While reincorporating a discontinued operation is possible, it is uncommon and would require careful disclosure to avoid misleading stakeholders. Companies are required to provide full transparency around these decisions to prevent any manipulation of financial information.
Best,
365 Team
Thank you so much for your answers!
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