How to Account for Discontinued Operations on an Income Statement?

Discontinued Operations are parts of a business that have been sold, disposed of, or abandoned and are no longer considered a part of the company’s ongoing operations.

These operations are reported separately in the financial statements due to the significant impact they can have on a company’s financial results.

Why do Discontinued Operations matter?

Discontinued Operations are essential because they can significantly impact a company’s financial performance. 

When a business disposes of a significant component of its operations, it may result in a gain or loss material to its financial statements. 

By reporting these operations separately, investors and other stakeholders can better understand the company’s financial performance.

How to Account for Discontinued Operations on an Income Statement? Step by Step

When a company discontinues an operation, the business will be sold, closed down, or spun off to a subsidiary. 

In such a case, the company needs to account for the discontinued operation in its financial statements, specifically the income statement. 

This is important because it helps investors and other stakeholders understand the discontinued operation’s financial impact on the company’s performance. 

Here are the steps to account for discontinued operations on an income statement:

Step 1:Identify the Discontinued Operation 

The first step is to identify the specific operation that is being discontinued. This could be a product line, a business segment, or a subsidiary. 

Once the company has identified the discontinued operation, it needs to separate the financial results of that operation from the rest of the business.

Step 2: Calculate the Results of the Discontinued Operation 

The next step is to calculate the financial results of the discontinued operation. 

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This includes revenues, expenses, gains or losses, and taxes. The company should also consider any costs associated with the discontinuation, such as severance pay or asset write-downs.

Step 3: Report the Results of the Discontinued Operation Separately 

The financial results of the discontinued operation should be reported separately on the income statement. 

The revenues, expenses, gains or losses, and taxes associated with the discontinued operation should be shown as a separate line item on the income statement.

Step 4: Calculate the Income from Continuing Operations 

After reporting the results of the discontinued operation, the company needs to calculate the income from continuing operations.

This is the income generated from the business’s ongoing operations, excluding the discontinued operation.

Step 5: Report the Results of Continuing Operations 

The results of continuing operations should also be reported separately on the income statement. 

The revenues, expenses, gains or losses, and taxes associated with continuing operations should be shown as a separate line item on the income statement.

Step 6: Calculate the Net Income or Loss 

Finally, the company needs to calculate the net income or loss, the total income generated from both the discontinued and continuing operations. The net income or loss should be reported at the bottom of the income statement.

It’s worth noting that the accounting treatment of discontinued operations can be complex and may require the expertise of a qualified accountant or financial professional. 

Companies must also adhere to specific accounting standards when accounting for discontinued operations. 

For example, under the Generally Accepted Accounting Principles (GAAP), a company can only report a discontinued operation if it is a separate major line of business or a significant geographical area of operations.

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What does an income statement’s ‘discontinued operations’ section refer to?

An income statement’s “discontinued operations” section refers to the financial results of a business segment or operation that has been or will be permanently discontinued.

This section reports the income or loss related to the operation that is being or has been sold, closed down, or spun off from the rest of the company.

The purpose of reporting discontinued operations separately is to provide a clearer picture of the company’s ongoing financial performance. 

By isolating the financial results of the discontinued operations, the income statement provides a more accurate representation of the company’s continuing operations, which are considered more relevant to investors and other stakeholders.

Examples of discontinued operations may include:

  • A product line that has been sold.
  • A subsidiary that has been spun off.
  • A manufacturing plant that has been closed down.

The financial results of these operations are reported separately in the income statement to provide a clear and transparent picture of the company’s economic performance.

Example of Discontinued Operations

To illustrate how Discontinued Operations work in practice, let’s look at a hypothetical example. 

Suppose XYZ Corp. decides to sell one of its divisions, Division A, for $10 million. The carrying value of Division A is $7 million. 

The gain on disposal would be calculated as follows:

$10 million (proceeds from disposal) – $7 million (carrying value of Division A) = $3 million gain on disposal

In this case, the $3 million gain on disposal would be reported separately in the financial statements as a component of Discontinued Operations.

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Conclusion

In conclusion, Discontinued Operations are an essential aspect of financial reporting that can significantly impact a company’s economic performance. 

By reporting these operations separately in the financial statements, investors and other stakeholders can better understand the proper financial health of a company. 

We hope this article provides a comprehensive overview of Discontinued Operations.