What are Discontinued Operations?
A ‘discontinued operation’ is a part of a business that either has been disposed of or is classified as held for sale. It could be a subsidiary that was acquired exclusively for resale, a major line of business or a major geographical area of operations.
A company that has disposed of a component of its entity or has classified it as held for sale will classify it as discontinued operations.
A company can report discontinued operations if the disposal transaction results in the removal of operations and cash flows of the component from company operations. The other condition that must be met is that the company will have no continuing involvement in the operations in the component after completing the disposal transaction.
Key Learning Points
- Discontinued operations are a part of a business that either has been disposed of or is classified as held for sale
- They are presented separately at the bottom of the income statement
- Discontinued operations are not part of the ongoing business and are not included in reported operating profit
Asset Disposal Example
In the case of the asset disposal happening after year-end, the subsidiary to be sold is deconsolidated to one line item in the accounts:
Adidas 2018 – Extract from Balance sheet
This helps financial analysts see the balance sheet on an ongoing basis without the potential divestiture being included. All the subsidiaries’ assets are included in the asset line item (inventory, PP&E etc.) as will all the liabilities in the liability line item.
Once the business is sold it will be removed from the balance sheet. However, if the sale is part way through the year the company will have received income from the subsidiary while it was owned.
Discontinued Operations in the Income Statement
The revenues and expenses of the sold business during the period it was owned in the year of sale will be put into one line item on the income statement. The benefit of collapsing all the revenues and expenses of the sold asset into one line (put after-tax) is to make the income statement as a whole a better indication of the future performance of the business:
Proctor and Gamble – Extract from income statement 2010
In the above case, Proctor and Gamble sold Pringles during 2010 – the deal closed before the year-end. As a result, the earnings for Pringles were deconsolidated into one line – showing the earnings from Pringles was $1,790mm for the part of 2010 Proctor and Gamble still owned the asset.
Discontinued Operations and Financial Analysis
Discontinued operations are reported in a separate line item in the income statement and are not part of the ongoing operational activities. Income generated from these operations is therefore not included in operating profit and EBIT.
Complications may arise in the calculation of EBITDA and adding D&A expenses back to calculated EBIT. A most common issue, in this respect, is D&A which has been allocated to discontinued activities. Income from discontinued activities is shown at the very bottom of the income statement and therefore will not have any impact on operating profit; thus D&A from discontinued activities should not be included in the add backs to operating profit.