Definition (plain)
– Discontinued operations are parts of a business — a business line, division, or asset group — that a company has sold, disposed of, or decided to terminate. They are shown separately from continuing operations on the income statement so users can tell what income and cash flows come from the business that will remain versus what has ceased.
Why this matters
– Separating discontinued operations improves clarity. Investors and analysts can assess ongoing earning power without distortion from one-time gains or losses tied to businesses that are no longer part of the firm. It also helps in transactions (for example, mergers or divestitures) by isolating the financial effect of the divested activities.
How discontinued operations are presented (basic rules from accounting practice)
– Presentation: The gain or loss from the discontinued operation is reported as a distinct subtotal on the income statement, shown net of its related income taxes. That subtotal is then combined with continuing operations to arrive at total net income.
– Related items: Even after a decision to discontinue, the component may produce a gain or loss in the reporting period; those results are included in the discontinued-operations subtotal.
– Post-reporting adjustments: Any later adjustments tied to prior discontinued operations (for example, changes to benefit plan obligations or contingent liabilities) are presented separately to avoid mixing with current continuing operations.
– Interest and overhead: If a buyer assumes debt associated with the disposed component, pre-sale interest expense tied to that component can be allocated to discontinued operations. However, under U.S. accounting practice, general corporate overhead cannot be charged to discontinued operations.
GAAP vs IFRS — high level
– GAAP (U.S. Generally Accepted Accounting Principles): There are specific conditions that must be satisfied before a component may be classified and presented as a discontinued operation. When those conditions are met, the component’s results are shown in the discontinued-operations section of the income statement, after related taxes.
– IFRS (International Financial Reporting Standards): IFRS sets similar but not identical criteria. One notable difference is that under IFRS an equity-method investment can be classified as held for sale and presented as discontinued if it meets the IFRS criteria. Under IFRS a company may also continue some involvement with a discontinued operation while still meeting the reporting criteria.
Common practical consequences
– Tax effect: Losses from discontinued operations often generate tax benefits (a tax “gain” or reduction in taxes), so the tax effect is reported with the discontinued subtotal.
– Investor analysis: Analysts generally strip discontinued
operations from measures of continuing performance, such as earnings per share (EPS), operating margin, and operating cash flow, because discontinued results are considered nonrecurring and can obscure trends in the core business.
Typical analyst adjustments
– Exclude after‑tax income or loss from discontinued operations when calculating continuing EPS, operating income, EBITDA, and related margins.
– Remove any gain or loss on disposal of the discontinued component from recurring profit measures.
– Reclassify related cash flows (operating, investing, financing) into a separate discontinued section of cash‑flow analysis.
– Note any tax effects tied to the discontinued results; analysts usually reflect the after‑tax impact only.
Quick checklist for companies and analysts when reporting or analyzing discontinued operations
1. Confirm classification criteria are met (component of entity; held for sale or disposal; represents strategic shift).
2. Present discontinued results net of tax in a separate line on the income statement.
3. Show gain or loss on disposal (if realized) in the discontinued section.
4. Restate prior‑period income statement amounts for comparability, if required.
5. Provide footnote disclosures: description of the component, timing and manner of disposal, pre‑tax income/loss, tax effect, carrying amounts, and cash‑flow information.
6. Recompute key metrics (EPS, EBITDA, operating margin) excluding discontinued items for trend analysis.
Worked numeric example
Assumptions:
– Continuing operations pre‑tax income: $1,200,000
– Discontinued operation pre‑tax loss: $(300,000)
– Tax rate: 25%
– Shares outstanding: 1,000,000
Step 1 — Compute after‑tax amounts:
– Continuing operations after tax = $1,200,000 × (1 − 0.25) = $900,000
– Discontinued operation after tax = $(300,000) × (1 − 0.25) = $(225,000)
Step 2 — Reported net income = $900,000 + (−$225,000) = $675,000
Step 3 — EPS calculations:
– Reported (all‑inclusive) EPS = $675,000 / 1,000,000 = $0.675 per share
– Continuing‑operations EPS (analyst focus) = $900,000 / 1,000,000 = $0.90 per share
Interpretation: the discontinued loss causes reported EPS to fall from $0.90 (continuing) to $0.675 (reported). Analysts who want to evaluate ongoing performance will typically use the $0.90 figure.
Presentation on the cash‑flow statement
– Cash flows attributable to discontinued operations are presented separately (netted) for operating, investing, and financing activities. This separation helps users see ongoing cash generation independently of disposal activity.
Other practical consequences
– Tax reporting: losses may produce tax benefits; the tax benefit is presented with the discontinued subtotal.
– Debt covenants: large gains or losses from disposal might affect covenant calculations if agreements do not exclude discontinued items. Review contract definitions.
– Management incentives: managers may time disposals to influence reported results or bonuses; scrutiny of disclosure timing and valuation assumptions is prudent.
– Comparability: frequent or recurring “discontinued” classifications can impair comparability and warrant a deeper look at strategy and reporting consistency.
Regulatory and standards notes
– U.S. GAAP and IFRS are similar in purpose but differ on specifics (for example, IFRS permits certain equity‑method investments to be treated as discontinued). Always consult the relevant standard for technical accounting and disclosure requirements.
Short practical checklist for readers analyzing a financial filing
– Find the discontinued operations line on the income statement and the related footnote.
– Verify whether prior periods were restated; if yes, use restated figures for trend analysis.
– Recompute EPS and key margins excluding discontinued items.
– Scan cash‑flow statement for separate discontinued cash‑flow information.
– Read footnotes for timing, terms of disposal, and the method used to measure any gain or loss.
Educational disclaimer
This explanation is for educational purposes only and does not constitute investment, tax, or accounting advice for your specific situation. Consult a licensed professional for personalized guidance.
Selected references
– Financial Accounting Standards Board (FASB) — Accounting Standards Codification (ASC) 205‑20 (Discontinued Operations), https://www.fasb.org
– IFRS Foundation — IFRS 5 Non‑current Assets Held for Sale and Discontinued Operations, https://www.ifrs.org
– U.S. Securities and Exchange Commission (SEC) — Staff Accounting Bulletin and reporting guidance, https://www.sec.gov
– PwC — Practical accounting guide to discontinued operations, https://www.pwc.com
– Investopedia — Discontinued operations overview, https://www.investopedia.com/terms/d/discontinued-operations.asp