Going concerned is an important accounting principle. It is an accounting term that explains that a company is financially strong and stable to carry on future business activities. Another term that closely relates to the going concern is the continued business operations.
Continued business operations are those activities that are the main operations of any business. We can call it the core business activities of any entity. More comprehensively, the continuing operations are all the activities of a business except the ones which have been discontinued.
The income from continued operations is calculated by subtracting all the operating expenses and tax on the operating income. It shows the company’s after-tax operating income, and most people confuse the income from continued operations with the operating income. We will also talk about this argument.
In this blog, we will talk about the continued and discontinued operations, income from continued operations, and why income from continued operations is so important for any business’s financial position.
What is Income From Continued Operations?
The income from the continued operation can be defined as,
The income for continued operations is the net income generated from the regular business activities of any entity. The income from continued operations is derived by subtracting all the operating expenses and tax on the operating income from the total revenues.’
IFRS 8 of the International Financial Reporting Standards has defined the operating segments and all the disclosure requirements for their incomes. It requires disclosure of revenues from all the contracts with the customers, internal customers, or intersegment customers. Besides, the standards require the entities to define their methods for defining an operating and non-operating segment.
The IFRS 8.22 requires business entities to disclose different types of products and services from which they generate their operating revenues. Different clauses under IFRS 8 regulates the financial reporting of operating segments.
Let’s see what a company’s continuing and discontinuing operations are.
Continuing Operations Or Operating Segments
All the operations except those that have been discontinued will be reported under continuing operations of a business. Let’s formally define continuing operations of the business.
For a continuing operation, two basic assumptions must hold.
- That operation must be normal, i.e., related to the nature of the business and profitable
- That operation must be expected to continue in the near future.
If these two assumptions hold for any business operation, it will be considered as a continuing operation or operating segment for that particular business. We can explain the concept of continuing operations with the help of examples.
Example 1: ABC Limited is a mobile manufacturing company
So, ABC limited is mobile manufacturing, and its plant is located in China. The company has once been a market leader for 2G and 3G mobile phones. As the new technologies of 4G and then 5G were introduced, their older versions became obsolete for the new market needs. They discontinued manufacturing 2g and 3g phones and entered the business of 4G and 5G devices.
From this case, we can easily identify that the company no more manufactures the 2G and 3G mobile phones. Therefore, they have been excluded from the category of continued operations. The 4G and 5G devices have taken over the place in the continued operations. All the revenues from the sales and manufacturing of 4G and 5G devices will come under continuing operations because these hold two assumptions of normal business and are expected to continue in the future.
Discontinued Operations or Non-Operating Segments
Discontinued operations of any business entity are those which have stopped generating normal income for a business. The IFRS 5 regulates the financial reporting of the discontinued operations and assets for sales.
We can formally define discontinued operations as,
Discontinued operations is an accounting term that refers to a business’s operations, which were once part of continuing operations. These are core parts of any entity’s product line that has been shut down or divested due to market needs or non-profitability.
The important principle of going concern has to be followed by the business entities to stay alive in the markets. The emergence of the discontinued operations in any business is not an abnormal event because companies have to adapt themselves to changing market needs.
For instance, a launch of new technology might make an older plant obsolete. In that case, the company will have to shut down the plant and move to new technology for survival.
For an operation to be declared as a discontinued operation following conditions must be met:
- The elimination of an operation from the cashflows and regular operations of the business
- The company’s rights of involvement in the day-to-day activities of the operation are ceased
The concept of discontinued operations can be well understood with an example.
Example 2: XYZ Limited has sold one of its product lines
XYZ Limited has sold one of its product lines to a retailer by an agreement. The agreement states that the retailer will pay 7% royalty to XYZ Limited on any sales related to that product line for the next three years.
If we analyze the situation, XYZ Limited will have no direct involvement in the product line’s operations and no cashflows from regular operations. It will be a discontinued operation for XYZ Limited.
Is Income From Continuing Operations Same As Operating Income
At most places, you will find a statement saying that income from the continuing operation is also called operating income. It is true to a certain point, but we can declare it as a fact. Let’s see how the income from continuing operations is different from operating income.
If we see the formula of income from continuing operations, it is earnings after tax but before discontinuing operations.
Revenues- operating expenses- amortization & depreciations- interest expense – tax
If we look at the operating income, its formula is
Revenues – operating expenses – depreciation & amortization
Both terms are the same thing, but their use is different.
The operating income translates the operating efficiency of an entity which is more like an internal metric.
Whereas the income from continuing operations is the most critical figure, it shows any business entity’s current financial health. The shareholders and investors use this information to assess their investment’s worth.
How To Calculate Income From Continuing Operations?
Now let’s see how we will calculate income from continuing operations of a business entity.
According to the Accounting Principals Board(APB) 30, the income statement will look like the table given below.
For the Year Ending Dec 31st, XXXX
|(-) Cost Of Goods Sold||(xxxxxx)|
|(-) Operating Expenses||(xxxxxx)|
|(-) Administrative Expenses||(xxxxxx)|
|Operating Profit/Income From Operations Before Interest And Tax||xxxxxx|
|(-) Interest Expense||(xxxxxx)|
|Earnings Before Tax||xxxxxx|
|(-) Tax Expense||(xxxxxx)|
|Income From Continuing Operations||xxxxxx|
Let’s describe some of the direct costs included in the cost of goods sold, operating costs, and administrative costs.
Cost Of Goods Sold
- Direct material –procurement of the raw material for the production
- Direct labor –the direct manpower and total labor hours involved
- Factory Overhead Costs –water, electricity, gas consumption
- Professional Fees – these are costs of delivering services, and it is more relevant to a service-based business
Operating Costs or Indirect Costs
- Salaries of the employees like production managers and quality assurance staff
- Depreciation and Amortizations
- Utilities that are not directly consumed for manufacturing
- Rent of the plant
- Salaries of corporate staff and managers
- Office supplies
- Office rent
- Depreciation of office building
- Insurance and amortization
Importance Of Income From Continuing Operations
Income from the continuing operations represents the true financial health of the company. It represents the future prospects of the company’s profits. Therefore, the investors can assess the expected return from their investment in the business entity.
Besides, the income from continuing operations is also important from a disclosure point of view. In the multistep income statement, the income from continuing operations shows the results of the business’s normal operations. According to the ruling of IFRS and GAAP, the entity should disclose the sources of income.
For instance, if a company is in car selling, but most of its income is coming from insurance, it will be a red flag. Therefore, disclosing the income for continuing operations is necessary from the compliance point of view.
Another reason the income from continuing operations is necessary is related to the management. Since it is close enough to the operating income, in fact, in most cases, income from continuing information. Therefore it is an important measure of operational efficiency. The internal management can have a better idea of their operations.
We have discussed the income from the continuing operations and discontinued operations. Since continuing operations are the primary source of income for any business entity, income from such operations is the true picture of financial position. Therefore, the income from continuing operations is important for the internal purposes and the external users of information.
We hope the article’s information will clear your concepts regarding the income from continuing operations and operating income.