Chapter 5 — Discontinued Operations
Chapter 5 — Discontinued Operations
5.1 Overview
The reporting of discontinued operations separately from continuing
operations is meant to provide stakeholders with information on assessing the
effects of a disposal on an entity’s ongoing operations. The operations of a
disposal group may only be presented as a discontinued operation once the assets
(and liabilities) meet the criteria to be classified as held for sale, have been
sold, or have been otherwise disposed of (e.g., abandonment) and only if the
disposal represents a strategic shift that has or will have a major effect on an
entity’s operations and financial results. Therefore, not all disposal transactions
qualify for discontinued-operations reporting. If the assets (and liabilities) of
the discontinued operation are classified as held for sale (rather than having been
disposed of), they are measured at the lower of their carrying amount or fair value
less costs to sell like other assets that are classified as held for sale under ASC
360-10.
5.2 Criteria for Reporting a Discontinued Operation
ASC 205-20
What Is a Discontinued
Operation?
45-1A A discontinued operation may
include a component of an entity or a group of components of
an entity, or a business or nonprofit activity.
A Discontinued
Operation Comprising a Component or a Group of
Components of an Entity
45-1B A disposal of a component of
an entity or a group of components of an entity shall be
reported in discontinued operations if the disposal
represents a strategic shift that has (or will have) a major
effect on an entity’s operations and financial results when
any of the following occurs:
-
The component of an entity or group of components of an entity meets the criteria in paragraph 205-20-45-1E to be classified as held for sale.
-
The component of an entity or group of components of an entity is disposed of by sale.
-
The component of an entity or group of components of an entity is disposed of other than by sale in accordance with paragraph 360-10-45-15 (for example, by abandonment or in a distribution to owners in a spinoff).
45-1C Examples of a strategic shift
that has (or will have) a major effect on an entity’s
operations and financial results could include a disposal of
a major geographical area, a major line of business, a major
equity method investment, or other major parts of an entity
(see paragraphs 205-20-55-83 through 55-101 for
Examples).
The operations related to a disposal of assets (and liabilities) are
reported in discontinued operations in the statement of operations if all of the
following criteria are met:
-
The disposed-of assets (and liabilities) together represent a component of an entity (or a group of components of an entity) (see the next section).
-
The disposal of the component “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results” (see Section 5.2.2).
In addition, a newly acquired business or nonprofit activity that
meets the held-for-sale classification criteria in ASC 205-20-45-1E upon acquisition
qualifies for reporting in discontinued operations regardless of whether the other
discontinued-operations reporting criteria are met. (See Section 5.6 for further discussion.)
5.2.1 Component of an Entity
The ASC master glossary defines a component of an entity as
follows:
A component of an entity comprises operations
and cash flows that can be clearly distinguished, operationally and for
financial reporting purposes, from the rest of the entity. A component of an
entity may be a reportable segment or an operating segment, a reporting
unit, a subsidiary, or an asset group.
Connecting the Dots
A discontinued operation may represent one or more components of an
entity. For convenience, the term “component” is used throughout this
publication.
The legal form of a component is not relevant, as demonstrated
by the inclusion of a subsidiary or a reporting unit in the definition. However,
we do not believe that a component can be at a lower level than an asset group.
Further, a disposal group represents the assets and liabilities that will be
disposed of together in a single transaction. Because a component does not have
to be disposed of in a single transaction, a component may consist of multiple
disposal groups.
Because the operations and cash flows of the component must be clearly
distinguishable from the rest of the entity, the financial information of the
component must be available. A disposal group can be a component even if the
parent retains certain assets associated with or used by the component to be
disposed of, such as cash, accounts receivable, other working capital, or
specific assets (e.g., IT systems, intellectual property, a manufacturing
facility, or headquarters). Entities must sometimes use judgment in determining
whether a disposal group constitutes a component.
Example 5-1
Sale of a Component to Multiple Buyers
Company C manufactures and markets men’s shoes and coats.
Company C discloses that it operates two segments under
ASC 280-10 and two lines of business — the Shoe Group
and the Coat Group. The operations and cash flows of the
Shoe Group can be clearly distinguished, operationally
and for financial reporting purposes, from the rest of
C. Therefore, the Shoe Group is a component of the
entity. In the fourth quarter of 20X6, C initiates and
closes on a transaction to sell the majority of the Shoe
Group’s manufacturing and distribution operations to
Company E. In addition, management, having the
appropriate level of authority, commits to a formal plan
to sell the remaining assets of the Shoe Group.
ASC 205-20 does not require that a
component be sold in a single transaction. If the Shoe
Group’s remaining assets and liabilities continue to
meet the requirements for held-for-sale classification,
C may continue to classify them as held for sale. See
Section 5.3
for considerations related to disposals that occur over
multiple reporting periods.
Example 5-2
Sale of an Entire
Entity
The owners of Company A, a manufacturing entity, enter
into an agreement to sell A in its entirety to Company
B. Because the operations being sold represent the
entire entity (and therefore are not distinguishable
from the rest of the entity), A does not meet the
definition of a component of an entity. Therefore, the
operations of A cannot be presented as discontinued
operations.
5.2.2 Strategic Shift That Has (or Will Have) a Major Effect
To report a discontinued operation, the disposal must represent
“a strategic shift that has (or will have) a major effect on an entity’s
operations and financial results.” ASC 205-20 does not define the terms
“strategic shift” and “major effect” but provides the following examples of
dispositions that represent strategic shifts that have (or will have) a major
effect on an entity’s operations:
-
A major geographical area.
-
A major line of business.
-
A major equity method investment.
-
Other major parts of an entity.
In addition, ASC 205-20-55 includes five examples of
dispositions that are strategic shifts that have or will have a major effect on
the entity’s operations and financial results and therefore qualify for
presentation as a discontinued operation:
-
The sale of a product line that represents 15 percent of the entity’s total revenues.
-
The sale of a geographical area that represents 20 percent of the entity’s total assets.
-
The sale of all the entity’s mall stores (which historically have provided 30 to 40 percent of the entity’s total net income and 15 percent of its current total net income) so that the entity can focus solely on its supercenter stores.
-
The sale of a component that is an equity method investment that represents 20 percent of the entity’s total assets.
-
The sale of an 80 percent interest in one of two product lines that accounts for 40 percent of total revenue.
The examples indicate that the assessment of whether a disposal
should be reported as a discontinued operation is both qualitative and
quantitative. A strategic shift implies that the disposal must result from a
change in the way management had intended to run the business. For example, if
management has a history of closing retail locations that operate at a loss, the
decision to close a number of stores operating at a loss in a given period might
have a major effect on an entity’s operations and financial results but would
not represent a strategic shift. The determination of whether a disposal
represents a strategic shift will be based on the entity’s specific facts and
circumstances.
Likewise, ASC 205-20 offers no bright lines regarding whether
the disposal has or will have a “major” effect on an entity’s operations and
financial results. However, the examples from ASC 205-20-55 indicate that a
disposal would have a major effect if it represents (1) 15 percent of the
entity’s total revenues, (2) 20 percent of the entity’s total assets, or (3) 15
percent of the entity’s total net income. Thus, we believe that “major” is a
quantitatively high threshold, especially when considered alongside the
disclosure requirements added to ASC 360-10 related to disposals of individually
significant components that do not qualify for discontinued operations (see
Chapter 6).
According to the examples, the disposal only has to have a major effect on one
metric (i.e., revenue, net income, or assets), not necessarily all three.
In addition, ASC 205-20 does not state which metrics must be considered. ASC
205-20 does not preclude consideration of the impact on other metrics such as
operating cash flows or EBITDA if they are relevant to investors and have been
used by management to communicate operating and financial results. We do not
believe that the assessment should be based on whether a sale results in a
significant one-time gain or loss to the entity but on whether eliminating the
operations and assets of the component will have a major effect on an entity’s
ongoing operations and financial results. Similarly, an entity may need to use
judgment in evaluating metrics when those metrics include the effects of events
considered to be nonrecurring, such as impairments.
In prepared remarks at the 2015 AICPA Conference on
Current SEC and PCAOB Developments, Barry Kanczuker, an associate chief
accountant in the SEC’s Office of the Chief Accountant, provided the following
insights regarding the staff’s views on strategic shift and major effect:
So how does one determine what represents a strategic shift
that has or will have a major effect? I would observe that the standard
requires judgment to determine whether a disposal meets the revised
definition for a discontinued operation. ASC 205-20 provides several
examples of what may constitute a strategic shift that will have a major
effect on operations and financial results. The examples include a sale of a
product line that represents 15% of total revenue; the sale of a geographic
area that represents 20% of total assets; and the sale of all stores in one
of two types of store formats that historically provided 30–40% of net
income and 15% of current net income. We have heard suggestions that the
quantitative factors included in the examples are meant to create thresholds
by which to determine whether a disposal represents a strategic shift that
has a major effect on the entity’s operations and financial results. In my
view, the thresholds are illustrative and do not establish bright lines or
safe harbors.
A question also arises as to what
constitutes a financial result? I believe that judgment is required
to determine which financial results are indicative of a strategic shift
that has a major effect. I think there are certain “primary” metrics that
are prominently presented in the financial statements and communicated to
investors. For example, revenue, total assets and net income are items that
I would clearly consider to be relevant metrics. However, the identification
of other financial results may require judgment, with an eye toward what is
relevant from an investor’s perspective. It also may be helpful to
understand alternative measures, as certain operating metrics may also be
relevant, particularly where the Company has used the measure on a
consistent basis for communicating operating and financial results. I also
believe that it is prudent to consider the effect of the relevant financial
metric on the entity from the perspective of current, historical and
forecasted results. In my view, the guidance indicates a need to evaluate
the totality of the evidence, and there is no single financial metric that
is determinative in concluding that a disposal had a major effect on the
entity’s operations and financial results.
While
the guidance does not provide quantitative bright lines in determining
whether a disposal is a strategic shift that has a major effect, the less
significant a financial impact the disposal has on an entity, the stronger
the qualitative evidence would need to be. In evaluating whether the
qualitative evidence supports a strategic shift that has a major effect, I
think it is important to consider the prominence and consistency with which
the disposed component and related qualitative factors have been discussed
within periodic filings.
We believe that disposal of a reportable segment will often
qualify for presentation as a discontinued operation, while an entity will need
to use judgment when the disposal consists of an operating segment, reporting
unit, or other parts of the entity. An entity will also want to consider the
extent to which information about the component has been provided publicly
(e.g., via the entity’s Web site, earnings releases, or MD&A) in assessing
whether a disposal represents a strategic shift. Further, we believe that an
entity should separately evaluate the criteria for reporting discontinued
operations at each level of financial statement reporting and that the
conclusions reached at the level of the stand-alone subsidiary may differ from
those reached at the level of the consolidated parent.
The examples of a strategic shift that has (or will have) a
major effect on an entity’s operations include the disposal of “other major
parts of an entity,” not just a major line of business or geographical region.
In the 2013 proposal on which ASU 2014-08 was based, the FASB
contemplated limiting the definition of a discontinued operation to a separate
major line of business or a major geographical area of operations. Paragraphs
BC13 and BC14 of ASU 2014-08 offer some insight into why the Board ultimately
decided not to limit the definition:
Some respondents
questioned whether disposals that include several different parts of an
entity other than an entire major line of business or major geographical
area of operations would qualify for discontinued operations reporting if
they represent a strategic shift. Some of those respondents noted that in
their experience it is rare that an entity ever disposes of an entire major
line of business or a major geographical area of operations. Additionally,
those respondents noted that a disposal transaction that includes several
different parts of an entity often could have a greater effect on an
entity’s operations and financial results than a disposal of an entire major
line of business or major geographical area of operations.
The Board concluded that the nature of the disposal and its
effect on an entity’s operations and financial results matter more than the
composition of the transaction. Therefore, the Board decided that a
discontinued operation could include different parts of an entity other than
an entire major line of business or a major geographical area of operations
as long as those parts are a disposal group that together represents a
strategic shift that has a major effect on an entity’s operations and
financial results.
The following examples in ASC 205-20-55 illustrate disposals
that would qualify for discontinued-operations presentation:
ASC 205-20
Example 1:
Consumer Products Manufacturer
55-84 An entity manufactures
and sells consumer products that are grouped into five
major product lines. Each product line includes several
brands that comprise operations and cash flows that can
be clearly distinguished, operationally and for
financial reporting purposes, from the rest of the
entity. Therefore, for that entity, each major product
line includes a group of components of the entity.
55-85 The entity has
experienced high growth in its discount cleaning product
line that has lower price points than its premium
cleaning product line. Total revenues from the discount
cleaning product line are 15 percent of the entity’s
total revenues; however, the discount cleaning product
line will require significant future investments to
increase its profits. Therefore, the entity decides to
shift its strategy of selling cleaning products at
multiple price points and focus solely on selling
cleaning products at a premium price point. As a result,
the entity decides to sell the discount cleaning product
line.
55-86 Because the entity shifts
its strategy of offering discount cleaning products to
consumers and because the discount cleaning product line
is one of five major product lines that is a major part
of the entity’s operations and financial results, the
disposal represents a strategic shift that is reported
in discontinued operations.
Example 2:
Processed and Packaged Goods
Manufacturer
55-87 An entity manufactures
and sells food products that are grouped into five major
geographical areas (Europe, Asia, Africa, the Americas,
and Oceania). Each major geographical area includes
several brands that comprise operations and cash flows
that can be clearly distinguished, operationally and for
financial reporting purposes, from the rest of the
entity. Therefore, for that entity, each major
geographical area includes a group of components of the
entity.
55-88 The entity has
experienced slower growth in its operations located in
the Americas, which accounts for 20 percent of the
entity’s total assets. Therefore, the entity decides to
shift its strategy of selling food products in that
geographical area and focus its resources on
manufacturing and marketing food products in its other
four higher growth geographical areas. As a result, the
entity decides to sell its operations in the
Americas.
55-89 Because the entity’s
operations in the Americas is one of five major
geographical areas that is a major part of the entity’s
operations and financial results, the disposal
represents a strategic shift that is reported in
discontinued operations.
Example 3:
General Merchandise Retailer
55-90 An entity that is a
general merchandise retailer operates 1,000 retail
stores in 2 different store formats — malls and
supercenter stores — throughout the United States. The
entity divides its stores into five major geographical
regions: the Northwest, Southwest, Midwest, Northeast,
and Southeast. For that entity, each retail store
comprises operations and cash flows that can be clearly
distinguished, operationally and for financial reporting
purposes, from the rest of the entity. Therefore, for
that entity, each retail store is a component of the
entity.
55-91 The entity has
experienced declining net income at its 200 stores
located in malls across all 5 major geographical
regions. Historically, net income from the 200 stores in
malls has been in a range of 30 to 40 percent of the
entity’s total net income. Total net income from the 200
stores in malls is down to 15 percent of the entity’s
total net income because of declining customer traffic
in malls. Therefore, the entity decides to shift its
strategy of selling products in malls and sell the 200
stores located in malls.
55-92 Because the entity
decides to shift its strategy of selling products in
malls and focus solely on its supercenter stores and
because the 200 stores located in malls are a major part
of the entity’s operations and financial results, the
disposal represents a strategic shift that is reported
in discontinued operations.
Example 4: Oil
and Gas Entity
55-93 This Example provides an
illustration of the guidance in paragraphs 205-20-45-1B
through 45-1C. In this Example, the entity disposes of a
component of an entity that is an equity method
investment representing a strategic shift that has a
major effect on the entity’s operations and financial
results and is reported in discontinued operations.
55-94 An entity that follows
the successful-efforts method of accounting produces oil
and gas in two major geographical areas (Europe and
Africa) that are each divided into several regions. Each
region comprises operations and cash flows that can be
clearly distinguished, operationally and for financial
reporting purposes, from the rest of the entity.
Therefore, for that entity, each major geographical area
includes a group of components of the entity.
55-95 In its operations located
in Africa, the entity operates through a joint venture
with another entity that is accounted for by the
reporting entity as an equity method investment. The
entity’s carrying amount of its investment in the joint
venture is 20 percent of the entity’s total assets.
Because of significant investments needed in its
operations in Europe, the entity decides to shift its
strategy of operating in Africa to focus on its
operations in Europe and sell its stake in the joint
venture.
55-96 Because the entity shifts
its strategy of operating a joint venture to focus on
its operations in Europe where it maintains full control
and because its operations in Africa are a major part of
the entity’s operations and financial results, its
disposal represents a strategic shift that is reported
in discontinued operations.
5.3 Disposals That Occur Over Multiple Reporting Periods
A component of an entity may be as low a level as an asset group (see
Section 2.3). However, to qualify for
discontinued-operations presentation, the disposal must have a major effect, which
must be quantitatively significant. Sometimes management plans to dispose of a group
of components but those components will qualify as held for sale or will be disposed
of over multiple reporting periods. In such cases, the disposal may represent a
strategic shift in its entirety but the component or components that are disposed of
or classified as held for sale in any individual reporting period may not have a
quantitatively major effect.
We believe that, in such instances, entities may assess, at the time the plan is
formalized, whether the overall plan represents a strategic shift that has or will
have a major effect on an entity’s operations and financial results, provided that
the plan will be executed within a reasonable amount of time. However, we also think
that before reporting any component in discontinued operations, it is appropriate
for entities to wait until the components that are classified as held for sale or
that have been disposed of, in aggregate, have a major effect. Then, the results of
any components that were classified as held for sale or disposed of in prior periods
in accordance with the plan should be reclassified to discontinued operations. We do
not believe that the remaining components should be presented in discontinued
operations until they are classified as held for sale or otherwise disposed of, even
if they are part of the overall plan. Entities should also provide appropriate
disclosures describing the plan.
5.4 Normally Occurring Disposals
Entities in certain industries (e.g., real estate, private equity, or retail)
may frequently enter into disposal transactions that may be quantitatively major. If
the dispositions are part of the entity’s ongoing strategy, it is likely that they
would not represent a strategic shift for the entity. The determination of whether a
normally occurring disposal is a strategic shift will be based on the entity’s
specific facts and circumstances.
Example 5-3
Normally Occurring Disposals
Entity A is a real estate investment trust (REIT) that acquires properties in
areas experiencing a downturn in prices. Entity A renovates
the properties, leases them, and manages them until it is
able to capitalize on appreciation by selling them.
In the current reporting period, A sells a property, identifying the property
sold on the basis of its assessment of whether the sale
would provide it with a specified rate of return. Regardless
of whether the sale has or will have a major effect on A’s
operations and financial results (e.g., reduced rental
income and maintenance costs), the sale would most likely
not represent a strategic shift because it occurred as part
of A’s ongoing strategy to sell the properties that have
appreciated sufficiently to provide A with its specified
rate of return.
If, however, the property sold represented A’s only such
property of a particular class or in a particular
jurisdiction, the sale might represent a strategic shift if
A plans to exit entirely that class of property or
jurisdiction.
5.5 Continuing Involvement
While ASC 205-20 does not preclude discontinued-operations reporting if the
entity has continuing involvement with the
disposed-of component, we believe that entities
should consider the nature, time frame, and extent
of any continuing involvement in determining
whether there has been a strategic shift that has
(or will have) a major effect on their operations
and financial results. Continuing involvement may
be indicated by, for example, (1) supply chain and
distribution agreements, (2) financial guarantees,
(3) options to repurchase assets that were
disposed of, and (4) retained equity method
investments (but generally not retained cost
method investments).
ASC 205-20-50-4A and 50-4B require entities to disclose the nature of any
significant continuing involvement with a discontinued operation after the disposal
date. See Section 7.7.3 for
more information about those disclosure requirements.
ASC 205-20-55-97 through 55-101 contain the following example of a disposal transaction in which the
entity retains a significant investment in the discontinued operation:
ASC 205-20
Example 5: Sports Equipment Manufacturer
55-97 This Example provides an illustration of the guidance in paragraphs 205-20-45-1B through 45-1C. In this
Example, the entity sells 80 percent of a group of components of an entity representing a strategic shift that
has a major effect on the entity’s operations and financial results and is reported in discontinued operations.
55-98 An entity that manufactures and sells sports equipment has two product lines that serve the football
and baseball markets. Each product line includes several different brands that each comprise operations and
cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of
the entity. Therefore, for that entity, each product line includes a group of components of the entity.
55-99 The entity decides to shift its strategy of trying to sell products to the baseball equipment market, which
accounts for 40 percent of its revenues, and focus more on serving its customers in the football equipment
market. However, the entity decides to retain some exposure to the baseball equipment market by selling only
80 percent of the group of components in its product line that serves the baseball market to another entity.
55-100 Because the entity decides to shift its strategy of trying to sell products to the baseball equipment
market by selling 80 percent of the group of components of the entity in that product line and because the
portion sold comprises a major part of the entity’s operations and financial results, its disposal represents a
strategic shift that is reported in discontinued operations.
55-101 Because of the entity’s significant continuing involvement after the disposal date, the entity provides
the disclosures required by paragraphs 205-20-50-4A through 50-4B.
5.6 A Business or Nonprofit Activity Classified as Held for Sale Upon Acquisition
ASC 205-20
A Discontinued Operation Comprising a Business or Nonprofit Activity
45-1D A business or nonprofit
activity that, on acquisition, meets the criteria in
paragraph 205-20-45-1E to be classified as held for sale is
a discontinued operation. If the one-year requirement in
paragraph 205-20-45-1E(d) is met (except as permitted by
paragraph 205-20-45-1G), a business or nonprofit activity
shall be classified as held for sale as a discontinued
operation at the acquisition date if the other criteria in
paragraph 205-20-45-1E are probable of being met within a
short period following the acquisition (usually within three
months).
Pending Content (Transition Guidance: ASC
805-60-65-1)
45-1D A business or nonprofit activity
that, on acquisition or upon formation of a joint
venture, meets the criteria in paragraph
205-20-45-1E to be classified as held for sale is
a discontinued operation. If the one-year
requirement in paragraph 205-20-45-1E(d) is met
(except as permitted by paragraph 205-20-45-1G), a
business or nonprofit activity shall be classified
as held for sale as a discontinued operation at
the acquisition date or the formation date if the
other criteria in paragraph 205-20-45-1E are
probable of being met within a short period
following the acquisition date or the formation
date (usually within three months).
Changing Lanes
In August 2023, the FASB issued ASU 2023-05, under which an entity that
qualifies as either a joint venture or
a corporate joint venture (as defined
in the ASC master glossary, is required to apply a new basis of accounting
upon the formation of the joint venture. The ASU’s amendments “are effective
prospectively for all joint venture formations with a formation date on or
after January 1, 2025.” Early adoption is permitted.
Specifically, the ASU amends ASC 205-10-05-3(b), and makes
related amendments to ASC 205-20, to indicate that a “business or nonprofit
activity that, on acquisition or upon formation of a joint venture, is
classified as held for sale” by the newly formed joint venture, would be
reported as a discontinued operation.
A business or nonprofit activity that meets the held-for-sale classification
criteria on acquisition
(see
Section 3.5.5)
is reported as a discontinued operation regardless of
whether its disposal will represent a strategic shift or have a major effect on the
entity’s operations or financial results. The FASB’s rationale was that if an entity
classifies a business as held for sale at the time of acquisition, the business was
never considered part of an entity’s continuing operations and should therefore be
reported in discontinued operations.
See
Section 7.10 for a
description of the related disclosure requirements, which are more limited than
those for other types of disposals.
5.7 Consideration of Subsequent Events for Assessing Discontinued- Operations Presentation
ASU 2014-08 (codified in ASC 205-20) deleted the previous guidance, under which
the evaluation of whether a disposal qualified for
discontinued-operations presentation took into account events that
occurred after the balance sheet date but before the financial
statements are issued or are available to be issued. This previous
guidance was inconsistent with the guidance in ASC 360-10-45-13,
which indicates that the evaluation of whether a component meets the
held-for-sale criteria is performed as of the balance sheet date
(see Section
3.10). Therefore, entities should determine
whether the held-for-sale criteria and the discontinued-operations
reporting criteria are met as of the balance sheet date. Those
determinations are not affected by events that occur after the
balance sheet date but before the financial statements are issued or
are available to be issued.
Under ASC 205-20-50-3, in the period in which an entity changes its plan for
selling a discontinued operation, the entity must disclose “a
description of the facts and circumstances leading to the decision
to change that plan and the change’s effect on the results of
operations for the period and any prior periods presented.” We
believe that if the entity decides not to sell a component after the
balance sheet date but before the financial statements are issued or
are available to be issued, the entity should consider providing the
disclosures required by ASC 205-20-50-3 (see Section
7.7.1) about its change in plan.