What it means
Companies restructure. They sell divisions that no longer fit, close chains that do not make money, and withdraw from countries where they cannot compete.
When they do, the income statement for the year mixes the results of the business that will carry on with the results of the business that is leaving, and often with a large gain or loss on the exit. A reader trying to judge the company's prospects wants to see the continuing business on its own, and to know what the exit cost.
The discontinued operations presentation provides both: the continuing operations are shown line by line down to profit after tax, and the discontinued operation is shown as a single line below that, comprising its after-tax trading result for the period and the after-tax gain or loss on its disposal or remeasurement. Not every closure or sale qualifies.
The component must be a separate major line of business or geographical area, or part of a single coordinated plan to dispose of one, or a subsidiary acquired exclusively with a view to resale. It must be operationally and financially distinguishable, so that its results can be separated.
Closing an unprofitable product, shutting a few stores or exiting a minor activity is a restructuring within continuing operations, not a discontinued operation, and the standards are specific in order to stop companies presenting every disappointing activity as "discontinued" and thereby flattering the continuing figures. The trigger is either the actual disposal or closure, or the classification of the component as held for sale, which occurs when management is committed to a plan to sell, the component is available for immediate sale in its present condition, an active programme to find a buyer has begun, the sale is highly probable within a year, and the asking price is reasonable.
From that point the component's assets are shown separately on the balance sheet as held for sale, measured at the lower of their carrying amount and fair value less costs to sell, and are no longer depreciated. Any write-down to fair value less costs to sell is part of the discontinued result.
The presentation has consequences for analysis. Earnings per share is reported for continuing operations and for the total, and analysts and valuation multiples generally use the continuing figure, since it is the best guide to future earnings.
The prior year's income statement is restated to show the same component as discontinued, so that the continuing results are comparable across years. The cash flow statement shows the operating, investing and financing cash flows of the discontinued operation separately, either on the face or in the notes.
Because a discontinued operation's costs of exit, such as redundancies, lease terminations and asset write-downs, are gathered into the discontinued line, the continuing profit can look clean while the total profit or loss for the year is very different, and a reader should look at both. The main judgement, and the main area of abuse, is what qualifies.
A company that classifies a loss-making activity as discontinued removes its losses from the continuing results and presents them as a one-off, which is legitimate if the activity is a major line of business being exited and misleading if it is an ordinary underperformer being dressed up. Auditors and regulators test the classification against the criteria, and readers should read the description of what has been discontinued and ask whether it is really a separate business.
A pattern of "discontinued operations" year after year suggests a company whose continuing results are being systematically flattered.
In practice
Real-world examples.
Example
A retailer closes its 60-store furniture chain, which was a separate reporting segment, and presents its trading losses and $20,000,000 of closure costs as a discontinued operation, restating the prior year.
Example
An industrial group sells its European subsidiary, a separate geographical area, and reports a gain on disposal of $35,000,000 after tax in the discontinued line while its continuing operations show a modest profit.
Example
A company that closes a single unprofitable factory out of eight is told by its auditors that the closure is a restructuring within continuing operations, not a discontinued operation, because the factory is not a separate major line of business.
Think of it
“Discontinued operations are business parts you're getting rid of-shown separately because they won't continue.
Formula
Calculation
Profit (loss) from discontinued operations = After-tax trading result of the component for the period + After-tax gain (loss) on disposal or on remeasurement to fair value less costs to sell
Gain (loss) on disposal = Net proceeds minus Carrying amount of net assets disposed of minus Costs of disposal (before tax), then less the related tax
Profit for the year = Profit from continuing operations + Profit (loss) from discontinued operations
Earnings per share is reported separately for continuing operations and in total
Worked example. A group with revenue of $50,000,000 and profit before tax of $4,000,000 sells a division during the year. The division had revenue of $12,000,000 and operating profit of $800,000 up to the date of sale; the group recorded a loss on disposal of $1,500,000 before tax. The tax rate is 25%.
- Continuing operations: revenue $38,000,000; profit before tax $3,200,000; tax $800,000; profit from continuing operations $2,400,000
- Discontinued operation: trading profit $800,000 less tax $200,000 = $600,000; loss on disposal $1,500,000 less tax credit $375,000 = $1,125,000 net; loss from discontinued operations = $600,000 minus $1,125,000 = $525,000
- Profit for the year = $2,400,000 minus $525,000 = $1,875,000
- With 5,000,000 shares: earnings per share from continuing operations $0.48; from discontinued operations minus $0.105; total $0.375
The prior year is restated: its continuing operations exclude the division's revenue of $11,500,000 and operating profit of $900,000 for that year, which are moved to a single discontinued line of $675,000 after tax, so that the continuing figures for the two years are comparable.
Held for sale measurement. If instead the division were classified as held for sale at the year end, with net assets of $9,000,000 and an expected sale price of $8,000,000 less $300,000 of costs to sell, it would be written down to $7,700,000: an impairment of $1,300,000 before tax, included in the discontinued result, and depreciation of its assets would stop.Case study
Seen in the real world.
A consumer products group had two divisions: a food business that was profitable and growing, and a homewares business that had lost money for three years. The board decided to sell the homewares division and, having appointed advisers and begun marketing it, classified it as held for sale at the year end.
In the annual report, the group's continuing operations showed revenue of $38,000,000 and profit after tax of $2,400,000, an improvement on the restated prior year; the discontinued line showed the homewares division's trading loss and a $4,000,000 write-down to fair value less costs to sell, a net loss of $3,900,000 after tax; and the group's total profit was a loss of $1,500,000. The chief executive's statement emphasised the continuing results and the "clean" business that would remain.
Analysts took the presentation at face value in one respect and not in another. They valued the group on its continuing earnings, as the standard intends, and the share price rose on the announcement. But two analysts noted that the "continuing" food business had been carrying a share of head office costs that would not disappear with homewares: $1,200,000 of central costs previously allocated to homewares had been moved to the discontinued line on the basis that they related to the division, whereas most of them, in the analysts' view, were group costs that the continuing business would still bear after the sale.
Adjusting for that, continuing profit was nearer $1,500,000 than $2,400,000. The auditors had accepted the allocation on the grounds that it followed the group's established segment reporting, but the analysts' point was about the future, not the accounting.
The sale completed six months later at a price close to the written-down value. The following year's continuing results showed the effect the analysts had predicted: central costs were higher than the "continuing" figure had implied, and profit after tax was $1,700,000. The finance director's investor presentation acknowledged the stranded costs and set out a plan to reduce them.
The episode illustrated both sides of the discontinued operations presentation: it had correctly separated a business the group was leaving from one it was keeping, and it had also, within the rules, presented the continuing business in a more favourable light than the following year justified. Readers who had asked what costs would actually leave with the division had the better estimate.
Watch out
Common mistakes.
- Classifying an ordinary underperforming activity as a discontinued operation when it is not a separate major line of business or geographical area, which flatters continuing results and misleads readers.
- Valuing a company on continuing earnings without asking which costs will actually leave with the discontinued operation; stranded central costs often remain and reduce future continuing profit.
- Continuing to depreciate assets classified as held for sale, or failing to write them down to fair value less costs to sell when that is below carrying amount.
Questions
People also ask.
What is the difference between a discontinued operation and a restructuring?
A discontinued operation is the exit from a separate major line of business or geographical area, presented as a single after-tax line. A restructuring is a reorganisation within the continuing business, whose costs are shown within continuing operations, sometimes as a separately disclosed item.
Why is the prior year restated?
So that the continuing operations are comparable between years. Without restatement, the prior year would include the discontinued operation and the current year would not, and the trend in the continuing business would be obscured.
How should investors use the discontinued operations figure?
As a guide to what the exit cost and what the ongoing business earns, while checking that the classification is justified and that the continuing figures do not exclude costs the business will still bear. Both continuing and total earnings per share should be read.
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