ASC 205-20: Accounting for Discontinued Operations

When a company sells a part of its business, specific accounting rules apply to ensure financial reports remain clear. The Financial Accounting Standards Board (FASB) provides this guidance under Accounting Standards Codification (ASC) Topic 205-20. This standard governs how a company reports the financial impact of a business segment it has disposed of or intends to dispose of. The function of ASC 205-20 is to distinguish between the financial results of a company’s continuing operations and those that are ceasing. This separation helps investors and other stakeholders forecast the company’s future performance based on its core business activities, as it prevents a one-time sale from distorting the results of retained operations.

Identifying a Discontinued Operation

Before a company reports a part of its business as a discontinued operation, it must meet specific criteria. The part being sold must qualify as a “component of an entity.” A component has operations and cash flows that can be clearly distinguished, operationally and for financial reporting, from the rest of the company. This could include a reportable segment, an operating segment, a subsidiary, or a distinct asset group.

The disposal must also represent a “strategic shift” that has, or will have, a major effect on the company’s operations and financial results. A strategic shift is an event that changes the fundamental nature of the business. Examples include the disposal of a major line of business or the exit from a major geographical area, like a retailer closing all its stores in Europe.

The sale of a single factory in a network of many or the discontinuation of a minor product line would not meet this threshold. The assessment requires judgment and is based on the unique facts and circumstances of the company.

The component must either be already disposed of or be classified as “held for sale.” To be classified as held for sale, several conditions outlined in ASC 360-10 must be met. Management must have committed to a formal plan to sell the component, it must be available for immediate sale in its present condition, and an active program to locate a buyer must have been initiated. The sale must also be probable within one year.

Financial Statement Presentation

Once a component is classified as a discontinued operation, ASC 205-20 dictates a specific presentation on the income statement, balance sheet, and statement of cash flows. The goal is to clearly segregate its results and provide a clear view of the disposal’s financial impact.

On the income statement, the results of the discontinued operation are presented separately from continuing operations as a single amount, net of tax. This line item appears after income from continuing operations and includes two elements: the income or loss from the component’s operations for the period, and any gain or loss from the disposal or write-down to fair value.

The balance sheet also requires segregation. The assets and liabilities of the component classified as held for sale must be presented separately from the company’s other assets and liabilities. The major classes of these assets and liabilities are either detailed on the balance sheet or disclosed in the notes, providing a clearer picture of the company’s continuing business structure.

A similar requirement applies to the statement of cash flows. The net cash flows from the discontinued operation must be presented separately from the cash flows of continuing operations. This segregation applies to all three categories: operating, investing, and financing.

Measurement and Disclosure Requirements

ASC 205-20 also provides rules for measuring the value of the component being sold and what information must be disclosed in the footnotes. The measurement rules ensure assets are not overstated, while the disclosures offer important context.

A component classified as held for sale is measured at the lower of its carrying amount or its fair value less costs to sell. Costs to sell are the incremental, direct costs from the disposal, such as broker commissions or legal fees. A consequence of this classification is that depreciation and amortization on the long-lived assets within the component must cease.

The company must provide a narrative description of the facts and circumstances that led to the disposal, as well as the expected manner and timing of the sale. This gives users insight into the strategic decisions behind the transaction.

Further disclosures include detailing the major classes of assets and liabilities of the discontinued operation. The company must also disclose the gain or loss recognized on the disposal and provide a detailed reconciliation of the major line items making up the net income of the discontinued operation, such as revenue and cost of sales.