Discontinued operations is a term used in accounting to refer to parts of a company’s business that have been terminated and are no longer operational. In accounting, discontinued operations are listed separately on financial statements from continuing operations.
Discontinued operations is a term used in accounting to refer to the parts of a company’s business that have been terminated and are no longer operational.
Often, business lines will be classified as discontinued operations if they are no longer operational, have been removed from the company, or have been, or will be sold in the near future.
In accounting, discontinued operations are listed separately from continuing operations on financial statements so that external users of the statements do not become confused and inappropriately evaluate the profitability of the company.
Reasons for Discontinued Operations
Parts of a company’s business or product line will typically be classified as a discontinued operation if they are no longer operational, have been removed from the company, or have been, or will be sold (referred to as being “held for sale”). It is important to note that the discontinued operation needs to represent a separate major line of the business or geographical area of operations.
During the regular course of a company’s life, it will often undergo changes in its business structure, including the cancellation of product lines deemed obsolete or no longer profitable, the disposition of aged equipment, sales of various market segments, and shifts in their business model. All of the changes described above will lead to discontinuation, and therefore must be reported as discontinued operations on financial statements.
Discontinued operations must be recorded separately in compliance with the accounting regulatory standards, such as GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards). The reason that discontinued operations are recorded separately from continuing operations (the product lines or business areas still in operation) is to ensure that external stakeholders – such as shareholders or potential investors – do not become confused and inappropriately evaluate the profitability of the business.
Discontinued Operations under IFRS
Under the International Financial Reporting Standards (IFRS), discontinued operations are reported when they meet two criteria. Specifically, it is addressed in IFRS 5. Firstly, the asset or business component in question needs to be already disposed of or reported as being held for sale.
Secondly, the component needs to be identifiable as a separate business that is being removed from operation intentionally or a subsidiary of a component being held with the intent of sale in the near future.
Discontinued Operations under GAAP
Discontinued operations are treated slightly differently under the Generally Accepted Accounting Principles (GAAP). Similarly to IFRS, a company is allowed to report discontinued operations under GAAP when two criteria are met. The criteria for GAAP require that firstly, the transaction used to shut down the divested business will eliminate the operations and cash flow of the business from the overall operations of the company.
Secondly, the discontinued operation is not allowed to have significant continued involvement with the parent company, which is significantly different from IFRS. Another difference is that equity method investments are not allowed to be classified as being held for sale.
Taxation on Discontinued Operations
The issue of taxation with regards to discontinued operations can be rather complex. Discontinued operations often still make a gain or a loss in the accounting period in which it decided to cease operations. As such, the gains or losses need to be reported for tax purposes.
However, it is common that discontinued operations are no longer generating any revenue and are operating at a loss, hence its discontinuation. It means that some money may be realized from taxes, but at the same time, the losses relating to the discontinued operation need to be weighed against all the other product lines that are still in operation and are generating revenue.
In all likelihood, companies usually tend to still pay taxes assuming that the monies from their revenue-generating operations exceed that of their discontinued operations.