Discontinued Operations under US GAAP

In recent years, many companies are taking steps to optimize their operations. One way of doing this is by selling, winding down, or otherwise disposing of parts of their business that are underperforming compared to their core activities.

When it comes to financial reporting under US GAAP, this type of streamlining may be considered to meet the definition of Discontinued Operations, or “Disc Ops,” under the US GAAP framework. In this article, we help you walk through the evaluation model of what qualifies as Disc Ops within a company.

What Causes a Discontinued Operation?

As a company grows, it may notice that certain parts of its business don’t perform as well as others. It may take far more time and effort to create and sell certain products, or fewer customers/sales are interested in a product. These lower-performing parts of the business result in lower, or even negative profits, and can drag on the overall success of the business.

When this happens, Company ABC’s management may make the decision that it needs to cut these underperforming units, so it can focus on where it is most successful. To do this, they may sell those parts of the business, or even abandon/wind-down the operations if a sale is not achievable. Examples of this could be an unsuccessful product line, an underperforming location/geography, or an entire business/entity.

These types of activities to remove certain parts of a company’s business are what could potentially be considered as Disc Ops under US GAAP.

Definition of a Discontinued Operation

In order for a part of a business to meet the definition of a Discontinued Operation under US GAAP guidance, it must meet 3 key criteria:

Criteria #1: Component of an Entity

First, the part of the business must be considered its own separate business component. This means that its operations and cash flows can be reasonably separated and tracked.

The simplest example of this is a separate subsidiary or legal entity, or a group of subsidiaries/entities. However, other types of components could include specific departments, product lines, locations/regions, or however else a company tracks its separate business units. However, if financial results can’t be separated, such as certain assets within an office, then this would not be considered a component of the entity.

Think about how you and your company track your operations, including how they’re set up in your accounting systems. Are they easily separated and measured by subsidiary, location, department, etc.? And do the parts of the business being sold (or disposed of) consist of an easily separable component?

Criteria #2: Held-For-Sale Classification

Assuming the 1st criteria above is met, the component must also meet a certain criteria under US GAAP, consisting of whether the component is classified as “held-for-sale.” All 6 of the underlying criteria must be met for this to be achieved:

1. Management has committed to a plan to sell

2. The component is available for immediate sale in its present condition

3. An active program to locate buyers and other sale plans have been initiated

4. Sale of the component is probable within 1 year

5. The component is actively marketed at a price reflecting its current fair value

6. It is unlikely that significant changes to the plan will occur, or the plan will be withdrawn

If all of the above 6 criteria are not met, then the component does not meet the held-for-sale classification. Based on the progress of the component being sold, this can be a high hurdle to overcome.

Criteria #3: Strategic Shift

The third criteria to be met for Disc Ops is determining whether the sale or disposal of the component “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.”

This “strategic shift” can occur in different ways, such as exiting a major geography, a significant product line or line of business, a large group of locations, etc. There are multiple examples in the US GAAP guidance that evaluate having a major effect of a company’s operations based on a percentage of the following metrics:

• Revenue: 15% or more

• Assets: 20% or more

• Net Income: 15% or more

Note that these are a limited list of examples in the US GAAP guidance, and you should consider all the facts and circumstances of the component in question to determine if it represents a “strategic shift.”

Conclusion

If all 3 of the above criteria are met, then the component meets the definition of a Discontinued Operation under US GAAP.

Also, when the component is ultimately sold or otherwise disposed of, then Criteria #2 (Held-for-Sale classification) is no longer needed, and the component could be considered a Discontinued Operation if Criteria #1 (Component of an Entity) and #3 (Strategic Shift) are met.

Treatment of a Discontinued Operation

Concluding that the component to be sold/disposed of is a Discontinued Operation doesn’t necessarily change the accounting treatment for it, though there is specific accounting for assets/liabilities that meet the “held-for-sale classification.”

The main impact of Disc Ops is their presentation and disclosure. The following US GAAP requirements are noted for Disc Ops:

• P&L presentation of Discontinued Operations, separate from the company’s continuing operations, for current and prior periods presented, including:

  • Income/loss from Disc Ops

  • Gain/loss on disposal of the Disc Ops

  • Any related income tax benefit/expense

• Balance Sheet presentation of assets and liabilities for the Disc Ops, presented separately from the company’s other assets and liabilities, for current and prior periods

• Either on the Balance Sheet or in footnote disclosures, the major classes of assets and liabilities within Disc Ops, for current and prior periods

• Significant footnote disclosure requirements, which can be seen in the US GAAP Accounting Standards Codification (ASC) 205-20-50

Even if the component does not qualify as Disc Ops, there may still be some limited disclosure requirements within the company’s footnotes for the component in its period of sale/disposal, if it is considered an individually significant disposal:

• Pre-tax profit/loss for the period of disposal and/or held-for-sale classification

• If noncontrolling interest is involved, pre-tax profit/loss attributable to parent for the period of disposal and/or held-for-sale classification

• If you are an SEC/public filer, prior periods are required for disclosure as well

As you may see, whether you are considering a sale/spinoff, wind-down, or other form of disposal for certain parts of business, the evaluation of whether it is considered Disc Ops under US GAAP can be complex, and the resulting financial reporting can be extensive. So, make sure you take the time to review accordingly.

Not sure where to start? Schedule a discovery call with our team of technical accounting experts to help you navigate every step of the process.