7.4 Presentation of Income Statement Items in Discontinued Operations

7.4.1 Asset Impairment Charges

Impairment charges related to the assets of a disposal group reported in discontinued operations should be included in discontinued operations in the current and prior periods, respectively. Such charges might include impairments related to PP&E, intangible assets, and goodwill. It may be appropriate to calculate the amount of a goodwill impairment charge on a relative fair value basis if the goodwill assigned to the disposal group was calculated on a relative fair value basis (see Section 3.4.1). Because ASC 350 requires disclosure of cumulative goodwill impairment amounts, it is necessary to reasonably measure cumulative goodwill impairments, if any, related to businesses disposed of to eliminate such amounts from this ongoing disclosure.

7.4.2 Adjustments to Amounts Previously Reported in Discontinued Operations

ASC 205-20-45-4 states that “[a]djustments to amounts previously reported in discontinued operations in a prior period shall be presented separately in the current period in the discontinued operations section of the statement where net income is reported.”

See Section 7.7.2 for related disclosure requirements associated with adjustments to amounts previously reported.

7.4.2.1 Classification and Disclosure of Contingencies

ASC 205-20-45-5 indicates that the resolution of certain contingencies represents an adjustment to amounts previously reported and should be recognized in discontinued operations in the current period. In SAB Topic 5.Z.5 (codified in ASC 205-20-S99-2), the SEC staff provided the guidance below on the classification and disclosure of contingencies related to discontinued operations. While the SAB was not revised to reflect the amendments made by ASU 2014-08, we believe that it continues to provide relevant guidance.

SEC Staff Accounting Bulletins

SAB Topic 5.Z.5, Classification and Disclosure of Contingencies Relating to Discontinued Operations [Reproduced in ASC 205-20-S99-2]

Facts: A company disposed of a component of an entity in a previous accounting period. The Company received debt and/or equity securities of the buyer of the component or of the disposed component as consideration in the sale, but this financial interest is not sufficient to enable the Company to apply the equity method with respect to its investment in the buyer. The Company made certain warranties to the buyer with respect to the discontinued business, or remains liable under environmental or other laws with respect to certain facilities or operations transferred to the buyer. The disposition satisfied the criteria of FASB ASC Subtopic 205-20 for presentation as “discontinued operations.” The Company estimated the fair value of the securities received in the transaction for purposes of calculating the gain or loss on disposal that was recognized in its financial statements. The results of discontinued operations prior to the date of disposal or classification as held for sale included provisions for the Company’s existing obligations under environmental laws, product warranties, or other contingencies. The calculation of gain or loss on disposal included estimates of the Company’s obligations arising as a direct result of its decision to dispose of the component, under its warranties to the buyer, and under environmental or other laws. In a period subsequent to the disposal date, the Company records a charge to income with respect to the securities because their fair value declined materially and the Company determined that the decline was other than temporary. The Company also records adjustments of its previously estimated liabilities arising under the warranties and under environmental or other laws.

Question 1: Should the writedown of the carrying value of the securities and the adjustments of the contingent liabilities be classified in the current period’s statement of operations within continuing operations or as an element of discontinued operations?

Interpretive Response: Adjustments of estimates of contingent liabilities or contingent assets that remain after disposal of a component of an entity or that arose pursuant to the terms of the disposal generally should be classified within discontinued operations.FN56 However, the staff believes that changes in the carrying value of assets received as consideration in the disposal or of residual interests in the business should be classified within continuing operations.

FASB ASC paragraph 205-20-45-4 requires that “adjustments to amounts previously reported in discontinued operations that are directly related to the disposal of a component of an entity in a prior period shall be classified separately in the current period in discontinued operations.” The staff believes that the provisions of FASB ASC paragraph 205-20-45-4 apply only to adjustments that are necessary to reflect new information about events that have occurred that becomes available prior to disposal of the component of the entity, to reflect the actual timing and terms of the disposal when it is consummated, and to reflect the resolution of contingencies associated with that component, such as warranties and environmental liabilities retained by the seller.

Developments subsequent to the disposal date that are not directly related to the disposal of the component or the operations of the component prior to disposal are not “directly related to the disposal” as contemplated by FASB ASC paragraph 205-20-45-4. Subsequent changes in the carrying value of assets received upon disposition of a component do not affect the determination of gain or loss at the disposal date, but represent the consequences of management’s subsequent decisions to hold or sell those assets. Gains and losses, dividend and interest income, and portfolio management expenses associated with assets received as consideration for discontinued operations should be reported within continuing operations.

Question 2: What disclosures would the staff expect regarding discontinued operations prior to the disposal date and with respect to risks retained subsequent to the disposal date?

Interpretive Response: MD&AFN57 should include disclosure of known trends, events, and uncertainties involving discontinued operations that may materially affect the Company’s liquidity, financial condition, and results of operations (including net income) between the date when a component of an entity is classified as discontinued and the date when the risks of those operations will be transferred or otherwise terminated. Disclosure should include discussion of the impact on the Company’s liquidity, financial condition, and results of operations of changes in the plan of disposal or changes in circumstances related to the plan. Material contingent liabilities,FN58 such as product or environmental liabilities or litigation, that may remain with the Company notwithstanding disposal of the underlying business should be identified in notes to the financial statements and any reasonably likely range of possible loss should be disclosed pursuant to FASB ASC Topic 450, Contingencies. MD&A should include discussion of the reasonably likely effects of these contingencies on reported results and liquidity. If the Company retains a financial interest in the discontinued component or in the buyer of that component that is material to the Company, MD&A should include discussion of known trends, events, and uncertainties, such as the financial condition and operating results of the issuer of the security, that may be reasonably expected to affect the amounts ultimately realized on the investments.

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FN56 Registrants are reminded that FASB ASC Topic 460, Guarantees requires recognition and disclosure of certain guarantees which may impose accounting and disclosure requirements in addition to those discussed in this SAB Topic.

FN57 Item 303 of Regulation S-K.

FN58 Registrants also should consider the disclosure requirements of FASB ASC Topic 460.

Example 7-3

Classification of a Gain Related to a Retained Equity Interest Sold in a Subsequent Period

Company D, an SEC registrant, is proposing to sell a significant subsidiary, Company T, which qualifies for reporting as a discontinued operation. Because this transaction arose from an unexpected offer from Company X, a third party, D does not have immediate plans for use of the proceeds from this sale. Accordingly, D would like to retain an equity interest (common stock) of up to 10 percent for the next four to five years.

In addition, D has a put option on the retained equity interest in T to sell this interest over a four-year period to X. Company X also will receive a call option to purchase the equity interest retained by D at the end of the four-year period.

The gains resulting from D’s exercise of its put option to sell a portion of its retained interest in T, or the gains resulting from X’s exercise of its call option to purchase the remaining interest in T, should be reported in continuing operations since they (1) are not directly related to D’s initial sale of T to X and (2) have resulted from management’s decision to hold and then sell a cost method investment. Furthermore, any increases or decreases that may need to be reflected under other authoritative accounting pronouncements (e.g., ASC 320-10 and ASC 815) would be reported in continuing operations.

7.4.2.2 Settlements and Curtailments of Employee Benefit Plan Obligations

ASC 205-20-45-5(c) states that the “settlement of employee benefit plan obligations (pension, postemployment benefits other than pensions, and other postemployment benefits)” should be presented in discontinued operations in the current period “provided that the settlement is directly related to the disposal transaction.” This paragraph further notes that a “settlement is directly related to the disposal transaction if there is a demonstrated direct cause-and-effect relationship and the settlement occurs no later than one year following the disposal transaction, unless it is delayed by events or circumstances beyond an entity’s control.” By analogy, this concept would also apply to a curtailment of an employee benefit plan that is directly related to the disposal transaction. ASC 715-30-55-193 through 55-197 provide additional guidance on the impact of settlement or curtailment expenses that are directly associated with a disposal transaction, and ASC 715-30-55-239 through 55-252 contain a related example.

7.4.3 Allocation of Interest to Discontinued Operations

ASC 205-20

45-6 Interest on debt that is to be assumed by the buyer and interest on debt that is required to be repaid as a result of a disposal transaction shall be allocated to discontinued operations.

45-7 The allocation to discontinued operations of other consolidated interest that is not directly attributable to or related to other operations of the entity is permitted but not required. Other consolidated interest that cannot be attributed to other operations of the entity is allocated based on the ratio of net assets to be sold or discontinued less debt that is required to be paid as a result of the disposal transaction to the sum of total net assets of the consolidated entity plus consolidated debt other than the following:

Debt of the discontinued operation that will be assumed by the buyer
Debt that is required to be paid as a result of the disposal transaction
Debt that can be directly attributed to other operations of the entity.

45-8 This allocation assumes a uniform ratio of consolidated debt to equity for all operations (unless the assets to be sold are atypical — for example, a finance company — in which case a normal debt-equity ratio for that type of business may be used). If allocation based on net assets would not provide meaningful results, then the entity shall allocate interest to the discontinued operations based on debt that can be identified as specifically attributed to those operations. This guidance applies to income statement presentation of both continuing and discontinued operations (including the presentation of the gain or loss on disposal of a component of an entity). A decision as to interest allocation shall be applied consistently to all discontinued operations.

Interest expense and amortization of discounts, premiums, and debt issuance costs related to debt that will be assumed by the buyer or debt that must be repaid as a result of a disposal transaction should be reported in discontinued operations. We also believe that gains or losses (e.g., prepayment penalties) from the extinguishment of debt that is directly related to the component being disposed of should be included in discontinued operations.

ASC 205-20-45-7 states that “[t]he allocation to discontinued operations of other consolidated interest that is not directly attributable to or related to other operations of the entity is permitted but not required.” Entities that choose to allocate other consolidated interest to the discontinued operation should use the allocation approach described in ASC 205-20-45-7 and 45-8, under which a “uniform ratio of consolidated debt to equity for all operations” is assumed unless such an allocation would not provide meaningful results. In that case, the entity must “allocate interest to the discontinued operations based on debt that can be identified as specifically attributed to those operations.” In addition, we believe that if an entity chooses to allocate other consolidated interest to the discontinued operation, the entity should use the same allocation method to allocate amortization of discounts, premiums, and debt issuance costs.

ASC 205-20-45-8 also states that “[a] decision as to interest allocation shall be applied consistently to all discontinued operations.” Further, as noted in ASC 205-20-S99-3:

The SEC staff will expect registrants electing to allocate interest in accordance with paragraph 205-20-45-6 to clearly disclose the accounting policy (including the method of allocation) and the amount allocated to and included in discontinued operations for all periods presented.

7.4.4 Allocating Direct Expenses (but Not Indirect Expenses) to Discontinued Operations

ASC 205-20

45-9 General corporate overhead shall not be allocated to discontinued operations.

An entity should only include in discontinued operations direct operating expenses incurred by the discontinued operation that (1) are clearly identifiable as costs of the component (or group of components) being disposed of and (2) the entity will not continue to recognize on an ongoing basis.

Potential direct costs that may be reported in discontinued operations include:

Personnel costs for employees who worked solely for the disposed-of component.
Costs associated with amortization of intangible assets used by the disposed-of component and disposed of in the transaction.

Indirect expenses, such as allocated corporate overhead (e.g., shared facility costs, corporate shared service center costs) should not be included in discontinued operations.

Example 7-4

Costs That Are Not Costs of the Component

A company allocates the salary costs of its executive committee to all of its divisions on the basis of total revenues. No executive has direct responsibility for the division being disposed of; however, two executives will be transferred with the division. The division meets the criteria for reporting in discontinued operations. Because the costs are not clearly related to the division, the company may not include the salaries of the transferred executives in discontinued operations.

Connecting the Dots

ASC 420-10-S99-1 contains the following guidance on presentation of restructuring changes in discontinued operations:

The following is the text of SAB Topic 5.P.3, Income Statement Presentation of Restructuring Charges.

Facts: Restructuring charges often do not relate to a separate component of the entity, and, as such, they would not qualify for presentation as losses on the disposal of a discontinued operation.

Therefore, only restructuring changes that are directly related to the component (or components) to be disposed of may be included in discontinued operations.

Entities may need to carefully evaluate the facts and circumstances related to the nature of certain costs when determining whether such costs should be allocated to discontinued operations. For example, property insurance expense directly related to individual facilities that are part of the disposed-of component may be included in discontinued operations. However, it may not be appropriate to allocate a portion of the entity’s corporate cybersecurity insurance expense to the disposed-of component, even if the entity reasonably believes that the cybersecurity insurance expense may decrease in the future after the consummation of the disposal.

7.4.5 Allocating the Cost of Shared Assets to Discontinued Operations

Certain assets may be shared by components that will be disposed of and components that will be retained. If an entity will retain the shared assets, the expenses related to the shared assets should not be allocated to the discontinued operation because the entity will continue to recognize such costs on an ongoing basis.

Example 7-5

Allocation of Part of an Asset’s Cost to Discontinued Operations

Company T, a public entity, currently reports three segments. In the current year, T implements a new computer system that is purchased centrally and implemented and tailored separately for each of the three segments. After implementing the computer system, T enters into an agreement to sell one of the segments. The disposition of the segment will be reported as a discontinued operation.

Because T is retaining the central computer system and is not including it in the disposal group, T may not allocate a portion of the overall costs incurred on the new computer system to the discontinued operation being disposed of. In addition, if T recognizes any impairment related to the central computer system, the impairment would not be included in discontinued operations.

7.4.6 Intercompany Sales Between an Entity and a Discontinued Operation

We believe that if an entity and its discontinued operation had intercompany purchases and sales that were eliminated in consolidation, it is appropriate to gross up and recast those sales and expenses in continuing operations and discontinued operations if such sales or purchases will continue with the discontinued operation after the disposal. As a result, the amount of intercompany revenue and expenses that will remain with the consolidated group after the disposal would be reflected in continuing operations and the amount of intercompany revenue and expenses that will be disposed of would be presented in discontinued operations. However, such presentation would not be appropriate for intercompany sales for which the inventory has not yet been sold to third-party customers. Grossing up revenue and expenses for inventory that has not yet been sold to third-party customers would result in the presentation of revenue and expenses that exceed the amounts the entity would have reported in its consolidated financial statements after intercompany eliminations.

Example 7-6

Presentation of Intercompany Sales Related to a Discontinued Operation

Company A is a paper manufacturing company and owns a distribution business, Subsidiary X, that buys paper from A and then sells the paper to outside customers. In its consolidated financial statements, A has appropriately eliminated the intercompany sales between itself and X and therefore only recognizes the sales from X to customers.

Company A is planning to sell X to another paper manufacturer. After the disposal, X will continue to purchase paper from A to sell to outside customers. Therefore, A will continue to have sales to X that will not be eliminated when X is no longer a subsidiary. Company A has concluded that even though it will have continuing involvement with X after the disposition, the disposition of X should be presented in discontinued operations.

Assume that during the reporting period, A sells paper to X for $6 and makes a profit of $2 (i.e., cost of $4) and that X sells paper to outside customers for $7 and makes a profit of $1. In A’s consolidated financial statements, the intercompany sales of $6 will be eliminated along with the $6 cost of sales, leaving a profit of $3, as follows:

Therefore, A would present the following:

In continuing operations, revenue of $6, cost of sales of $4, and a profit of $2 representing the sales from A to X.
In discontinued operations, a profit of $1 representing the sales from X to outside customers.

After the disposal (if the facts are the same), when A sells paper to X, it will have the same $6 sale, $4 cost of sales, and $2 profit in its continuing operations and will not have the additional $1 profit from sales to the outside customers.

This presentation only applies to paper that was sold to third-party customers during the reporting period. Any profit on intercompany transactions between A and X for which the paper has not been sold to third-party customers during the reporting period should be eliminated.

7.4.7 Transition Services

When a component is sold or spun off, an entity often enters into agreements with the buyer or with the component to provide certain services to the component, usually for a specified period (e.g., one year). Such arrangements are often called “transition service arrangements.” The revenues and expenses associated with transition services provided to a discontinued operation after its disposal should be reported in continuing operations because such services are part of the entity’s continuing activities. The entity should use judgment in determining the income statement line item in which to report the income and expenses. For example, revenues from transition services would generally be recognized as other income if the services are not part of the entity’s recurring revenue-generating activities.

7.4.8 Changes in the Carrying Value of Assets Received as Consideration

In some transactions, an entity may receive noncash consideration in exchange for a discontinued operation. Question 1 from SAB Topic 5.Z.5 (codified in ASC 205-20-S99-2) states:

[T]he staff believes that changes in the carrying value of assets received as consideration in the disposal or of residual interests in the business should be classified within continuing operations. . . . Subsequent changes in the carrying value of assets received upon disposition of a component do not affect the determination of gain or loss at the disposal date, but represent the consequences of management’s subsequent decisions to hold or sell those assets. Gains and losses, dividend and interest income, and portfolio management expenses associated with assets received as consideration for discontinued operations should be reported within continuing operations.

7.4.9 Income Taxes

See Deloitte’s Roadmap Income Taxes for more information about income taxes related to discontinued operations.

7.4.10 Reflecting a Successor’s Discontinued Operations in the Predecessor Period

According to paragraph 13210.2 of the SEC Division of Corporation Finance’s Financial Reporting Manual (FRM), when an SEC registrant is a successor to a predecessor entity and meets the criteria for reporting a discontinued operation, the predecessor financial statements must be retrospectively recast “to reflect the impact of a successor’s discontinued operations.” Paragraph 13210.2 further states that “[r]egistrants should contact the staff if unusual facts and circumstances may prohibit the company’s ability to reclassify predecessor fiscal periods.”

Such presentation enhances comparability for the discontinued operation for all fiscal periods presented. However, if there are unique facts or circumstances that could potentially prevent the reclassification of predecessor periods the entity is advised to discuss the situation with the SEC staff. Although the staff’s views specifically apply to SEC registrants, we believe that private companies that present predecessor and successor financial statements may also consider following this guidance.

This SEC guidance is limited to discontinued operations and does not extend to certain other retrospective changes, such as the retrospective adoption of a new accounting principle or a change in accounting principle, which are not “pushed back” into the predecessor period. See Section A.16.2 of Deloitte’s Roadmap Business Combinations for more information.