Definition
A “discontinued operation” refers to a component of a business that has been sold, disposed of, or is held for sale in the near future. This component can be a product line, a geographical area, or a class of customers. The financial results of discontinued operations are reported separately in the income statement. This segregation is done to provide stakeholders with a clear view of the company’s continuing operations versus those that have been or will be divested.
Examples
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Retail Chain: A national retail chain decides to sell its underperforming electronics segment. The results from this segment will be classified as a discontinued operation and shown separately in the financial statements.
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Food Manufacturer: A food manufacturing company chooses to dispose of its non-core beverage division to focus on its primary food products line. The financial impact of this sale will be reported as a discontinued operation.
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Telecommunications Firm: A telecommunications company in the process of exiting the international market and selling off its overseas operations will classify the financial results of these overseas operations as discontinued.
Frequently Asked Questions (FAQs)
1. What qualifies as a discontinued operation?
A component or segment of an entity that has either been disposed of or is classified as held for sale, resulting in a strategic shift or major line of business exit.
2. How are discontinued operations presented in the income statement?
They are shown as a separate line item after income from continuing operations and before extraordinary items to distinguish them from ongoing, normal business activities.
3. Why is it important to classify discontinued operations separately?
This classification provides clearer financial reporting, helping users of financial statements to better assess the core operational performance of the company.
4. What impacts investors when a company classifies something as a discontinued operation?
It indicates a strategic shift and helps investors understand that the portion of the company’s income will no longer contribute to future earnings.
5. Are there any special disclosures required for discontinued operations?
Yes, additional disclosures are typically required, including the specifics of the operations being discontinued and the expected timeline of disposal.
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Continuing Operations: The parts of a business that are expected to continue in the foreseeable future.
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Extraordinary Items: Uncommon and non-recurring items in the financial statements.
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Held for Sale: Classification for assets intended by a company for sale rather than continuing use.
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Segment Reporting: Financial reporting for different divisions or segments of a company.
Online Resources
- Investopedia: Discontinued Operation
- Financial Accounting Standards Board (FASB): Discontinued Operations
Suggested Books for Further Studies
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield - Detailed chapters on various accounting principles, including discontinued operations.
- “Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott - Great for understanding different aspects of financial reporting.
- “International Financial Reporting and Analysis” by Mark Haskins, Ken Ferris, and Thomas Selling - Insightful book for understanding financial reporting on a global scale.
Fundamentals of Discontinued Operation: Accounting Basics Quiz
### What is a discontinued operation?
- [x] A business segment that has been disposed of or classified as held for sale.
- [ ] A business segment with continuous losses.
- [ ] A newly acquired segment.
- [ ] Any temporary business hardship.
> **Explanation:** A discontinued operation is a business segment that has either been disposed of or is classified as held for sale.
### Where are discontinued operations reported in financial statements?
- [ ] At the beginning of the income statement
- [ ] As an extraordinary item
- [x] As a separate line item after income from continuing operations and before extraordinary items
- [ ] Only in the footnotes
> **Explanation:** Discontinued operations are reported as a separate line item after income from continuing operations and before extraordinary items to provide clear information on the separation of continuing activities from discontinued ones.
### Why is it important for companies to report discontinued operations separately?
- [x] To provide clearer financial reporting and help stakeholders assess core business performance.
- [ ] To avoid tax liabilities.
- [ ] To enhance sales opportunities.
- [ ] To minimize operational difficulties.
> **Explanation:** Reporting discontinued operations separately allows stakeholders to better evaluate the operational performance of the continuing parts of the company.
### When a company classifies an operation as discontinued, what strategic signal might it send?
- [ ] Intent to expand market share.
- [ ][ Intent to reduce tax liability.
- [ ][ Completion of a major acquisition.
- [x] A strategic shift, or major part of its business exit.
> **Explanation:** Classifying an operation as discontinued often indicates a strategic shift such as exiting a major line of business.
### What adds to the complexity of accounting for discontinued operations?
- [x] Additional disclosures and separate reporting requirements.
- [ ] Purchasing new assets.
- [ ] Annual sales forecasting.
- [ ] Marketing efforts for new segments.
> **Explanation:** Discontinued operations come with additional disclosures and reporting requirements that add to accounting complexity.
### Does the classification of an operation as discontinued affect its treatment under tax laws?
- [x] Yes
- [ ] No
> **Explanation:** Discontinued operations might have different tax implications which need to be considered in financial reporting and strategic decision-making.
### What information is typically disclosed regarding discontinued operations?
- [ ] Only the name of the operation.
- [ ] Only the reason for discontinuation.
- [x] Details about the operation, reason for disposal, and expected disposal timeline.
- [ ] None of the above.
> **Explanation:** Comprehensive information, including details about the operation, reason for disposal, and expected disposal timeline, is typically required for proper disclosure.
### Can discontinued operations impact future financial projections?
- [x] Yes, they can lead to adjustments in future revenue and expense projections.
- [ ] No, they do not affect future financial projections.
> **Explanation:** Discontinued operations often impact future financial projections because they involve removing a revenue-generating segment from ongoing business activities.
### What is a typical characteristic of a discontinued operation?
- [x] It's no longer part of the company’s main business strategy.
- [ ] It generates the highest revenue.
- [ ] It represents a start-up cost.
- [x] It involves routine service expansions.
> **Explanation:** A discontinued operation typically represents a segment that is no longer aligned with the company's main business strategy and is either being disposed of or held for sale.
### Who benefits from the separate reporting of discontinued operations?
- [x] Investors, stakeholders, and financial analysts benefit from clearer and more transparent reporting.
- [ ] Only auditors.
- [ ] Only tax authorities.
- [ ] Only the company's management team.
> **Explanation:** Separate reporting of discontinued operations primarily benefits investors, stakeholders, and financial analysts by providing a clearer view of the company’s continuing operations.
Thank you for exploring the concept of discontinued operations with us and engaging in our informative quiz! Continue to enhance your accounting knowledge for professional growth.
