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.
________________________________________
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 would 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 Settlement 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.” ASC 715-30-55-193 and ASC
715-30-55-196 and 55-197 provide additional guidance on this topic, 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.
Indirect expenses, such as allocated corporate overhead, 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.
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. To gross 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.