Discontinued Operations: Definition, Reporting, and Why They Matter

Key takeaways
* Discontinued operations are parts of a business that have been sold, disposed of, or shut down and are reported separately from continuing operations.
* Separate reporting helps investors distinguish current, ongoing performance from results tied to activities that have ceased.
* GAAP and IFRS have different criteria for when an operation qualifies as discontinued; both require separate presentation on the income statement.
* The discontinued section shows the total gain or loss (net of tax) from the disposed activity and is combined with continuing results to produce net income.

What are discontinued operations?

Discontinued operations are segments, product lines, subsidiaries, or other identifiable business components that a company has disposed of or intends to dispose of. Because they no longer contribute to the company’s ongoing economic prospects, their results are presented separately from continuing operations to give a clearer picture of future performance.

Why separate them on the financial statements?

Separate presentation:
* Prevents one-time gains or losses from obscuring the trend in continuing earnings.
* Improves comparability across periods and companies.
* Clarifies the effect of divestitures on future cash flows—useful to investors, analysts, and potential acquirers.

How discontinued operations appear on the income statement

• The income statement reports the total gain or loss from the discontinued operation, then shows the related tax effect, producing a net discontinued-operations amount.
• That net amount is presented separately from continuing operations and then included in the calculation of overall net income.
• Adjustments related to prior discontinued operations (for example, for contingent liabilities or benefit-plan obligations) are typically reported separately to avoid confusion.
• Under GAAP, routine corporate overhead generally cannot be allocated to discontinued operations. If a buyer assumes debt or other obligations, pre-sale interest and related costs may be allocated to the discontinued component.

GAAP criteria for discontinued operations

Under U.S. GAAP, an item qualifies as a discontinued operation only if both conditions are met:
1. The disposal represents a strategic shift that will eliminate the cash flows and operations of a major line of business or geographic area.
2. After disposal, the reporting entity will have no significant continuing involvement in the operations of the disposed component.

IFRS criteria for discontinued operations

Under IFRS (IFRS 5 Non-current Assets Held for Sale and Discontinued Operations):
* The component must be disposed of or classified as held for sale.
* The component must be a distinguishable major line of business, a geographical area, or a subsidiary held with the intent to sell.
Differences from GAAP include the treatment of certain equity-method investments and some flexibility about the reporting entity’s involvement while a component is being prepared for sale.

Practical implications

• Investors should treat results from discontinued operations as nonrecurring when assessing future earnings power.
• Disposals can produce either gains or losses; losses may generate tax benefits in later periods.
• In merger and acquisition analysis, separating discontinued items clarifies what business will remain and how future cash flows are affected.

The bottom line

Discontinued operations isolate the financial effects of business components that have been or will be removed from ongoing operations. Properly identifying and reporting them—following GAAP or IFRS rules—improves transparency and helps users of financial statements make better assessments of a company’s continuing performance and outlook.