What Are Examples of Discontinued Operations?

In business, when a company decides to sell or shut down a significant piece of its operations, it is considered a major change in direction, not a routine adjustment. In accounting, this event is known as a discontinued operation, representing the disposal of a substantial part of a company’s business. Understanding what qualifies as a discontinued operation provides insight into a company’s long-term strategy and future earning potential. This article will clarify the accounting standards for this classification, explain its presentation in financial reports, and offer examples.

Criteria for Classification

For a part of a business to be classified as a discontinued operation, it must meet specific criteria under U.S. Generally Accepted Accounting Principles (GAAP). The primary requirement is that the disposal of the business unit represents a “strategic shift” that will have a major effect on the company’s operations and financial results. This is a move that fundamentally alters the nature and focus of the company.

A second condition is that the distinct part of the entity, called a “component,” has either been disposed of or is classified as “held for sale.” A component is a segment of the business with operations and cash flows that are clearly distinguishable from the rest of the company, such as a subsidiary or a specific group of assets.

For a component to be classified as held for sale, management must have a formal plan for the sale. The component must be available for immediate sale in its present condition, and an active program to find a buyer must be underway. The sale is expected to be completed within one year.

Examples of a strategic shift include selling a major geographical area of operations, divesting an entire line of business, or selling a significant equity method investment. A disposal could be considered major if it accounts for a significant portion of a company’s revenues or assets, with some guidelines suggesting thresholds like 15% of revenues or 20% of assets.

Financial Statement Presentation

When a business component meets the criteria for a discontinued operation, its financial results must be reported separately from the company’s ongoing activities. This distinct presentation provides clarity to investors about the performance of the continuing parts of the business. The separation prevents the results of the disposed unit from obscuring the underlying performance and trends of the core operations.

Income Statement

On the income statement, the financial results of the discontinued operation are removed from continuing operations and presented in a single line item. This line appears below the subtotal “Income from Continuing Operations.” It consolidates the income or loss from the component’s operations for the period and the gain or loss from the disposal or from writing down the component’s value. This combined amount is presented net of its related income tax effect, and prior periods shown are restated for comparability.

Balance Sheet

When a component is classified as held for sale, its assets and liabilities are aggregated and presented separately on the balance sheet. The assets of the disposal group are shown as a single line item, such as “Assets held for sale,” and the liabilities are similarly grouped. This separate presentation applies to the current period’s balance sheet and any prior periods presented for comparison.

Statement of Cash Flows

On the statement of cash flows, the cash flows generated by or used by the discontinued operation are separated from the cash flows of the continuing business. Companies are required to disclose the operating and investing cash flows of the discontinued operation. This information can be presented either on the face of the statement or in the footnotes to the financial statements.

Illustrative Scenarios and Examples

Consider a global consumer products company that manufactures both electronics and home appliances and decides to focus exclusively on its electronics business. If it sells its entire home appliance division, which has its own factories, distribution network, and brand identity, the action qualifies as a discontinued operation. The sale of a major line of business represents a clear strategic shift.

Another example is a national restaurant chain with a distinct network of locations in a foreign country. If the company’s management decides to exit the foreign market completely by closing all of its stores to concentrate resources on domestic growth, this would be a discontinued operation. The disposal of a major geographical area is an example of a strategic shift.

A final illustration involves a large automotive manufacturer that owns a subsidiary focused on producing commercial trucks. If the parent company sells this subsidiary to another entity to streamline its operations and focus on passenger vehicles, the sale would be reported as a discontinued operation.

What Does Not Qualify as a Discontinued Operation

It is also important to understand what does not meet the criteria. Disposals that are not considered a major strategic shift do not qualify. For instance, a large retail company with hundreds of stores that closes a single, underperforming location would not report this as a discontinued operation, as it does not represent a shift in the company’s overall strategy.

If a technology company that produces a wide range of software decides to phase out one minor product within a larger suite, this would not be a discontinued operation. Another scenario that would not qualify is a manufacturing company closing one of its several factories and outsourcing that production while continuing to sell the same products. In this case, the company has only changed its production method, not exited a line of business or geographic area.