NON-RECURRING ITEMS Discontinued Operations

CFA Level I
#1

Hey guys,

I am having some trouble with the following question:

On March 31st, ABC Corp. announced that it had reached an agreement to sell its XYZ subsidiary. However, the closing transaction did not take place until September 30th of that same year. XYZ had a total net income of $22,000 for the quarter ending March 31st, and a total net income of $84,000 for the nine months ending September 30th. If the gain (net of taxes) on the sale was $327,000, how much should ABC report as its earnings from discontinued operations for the year ending December 31st? A) $62,000 B) $411,000 C) $389,000 D) $327,000

The Right Answer is c. Explanation: XYZ only became regarded as a discontinued operation after March 31st. Therefore, all results before that date would be regarded as part of normal operations. However, all figures after that date would constitute earnings from discontinued operations. While total net income for the year from XYZ was $84,000, $22,000 of that was while XYZ was part of normal operations. Thus, the difference [$84,000-$22,000 = $62,000] constitutes earnings from discontinued operations. Furthermore, the entire gain on the sale is grouped the same way. Therefore, the total earnings from discontinued operations is: $62,000 + $327,000 = $389,000.

Two things are not quite clear to me:

  1. If I understood this correctly, the ’ measurement date’ would be March 31st and the time from then until the actual sale on September 30th is the ’ phaseout period’ (the terms ’ measurement date’ and ’ phaseout period’ are from Schweser notes and are not mentioned at all in the CFA curriculum). So everything income generated between ’ measurement date’ and ’ phaseout period’ is recorded as income from discontinued operations, correct? In this case $84,000-$22,000=$62,000.

  2. Why are the ‘Gain on the Sale’ not reported under income from continuing operations as an unusual or infrequent item, since they include: gains or losses from the sale of assets or part of the business.

I do see why we report it under discontinued operations since in the CFA curriculum it says under discontinued operations:

“…When a company disposes of or establishes a plan to dispose of one of its component operations and will have no further involvement in the operation, the income statement reports separately the effect of this disposal as a “discontinued” operation under both IFRS and US GAAP…”

This clearly requires that all of the effects of the sale (income during phaseout and gain or loss from selling it) need to be aggregated under discontinued operations.

But I don’t see, when we would ever have a case of a sale of a part of the business that is part of unusual or infrequent items, since we seem to always make that part of discontinued operations.

#2

I have searched online too , a financial organization sold its part of business and considered it as " part of Discontinued operation" , I dont think we might see it as a part of Unusual or infrequent items because ( The below points are from my childish brain and have not been taken from anywhere " in simple language they can be challenged")

  1. The amount is too high to be considered as unusual item and add to the income of normal going business. Might result into too high profit or loss for that year.

  2. The deal usually take 3-4 quaters in phaseout period and then too the profit and loss in that deal is not fixed and in the worst situation deal can even break , and to add to it the ongoing business might be making or losing money as time passes. To tackle this we segregate the discountinued business.

But this practise has been used to make financial staments more attractive ( using to segregate the loss making part of business) , for this the FASB issued a new guidance in 2014 , Which helps to draw a fine line between both the above,

link of the document is below ( small only has 2 pages)

https://www.pwc.com/us/en/cfodirect/assets/pdf/in-the-loop/selling-part-of-your-business.pdf

Hope this helps!

#3

Thank you so much for your response Ankit.

So if I understand the summary of the new guideline correcty, it will be harder in the future to consider the sell of an item as part of discontinued operations. But for now (or for the exam), the rule is that the sale of part of the business is part of discontinued operations and NOT an unusual or infrequent item.

Does anyone have an example of a case where we DO include the gains or losses from the sale of assets or part of the business in the unusual or infrequent items?

#4

Definition of a discontinued operationDefinition of a discontinued operation ( Please hold back the bold points in mind to find the difference)

US GAAP

A component of an entity should be classified as a discontinued operation if all of the following conditions are met:

  1. The component has been disposed of or is classified as held for sale.

2 . The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction.

  1. The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.

IFRS

A component of an entity should be classified as a discontinued operation if all of the following conditions are met:

  1. The component has been disposed of or is classified as held for sale.

The component:

(a) Represents a separate major line of business or geographical area of operations.

(b) Is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations, or

© Is a subsidiary acquired exclusively with a view to resale.

Now for the example of gains or losses from the sale of assets or part of the business in the unusual or infrequent items( anyone here should not take it personally or otherwise)

Cosider a terrorist attack on a building , and there was ABC co. It have only one office and the buildings office is 90% distroyed , now you are selling that office and reopening at other place , here you are selling a great part of your business asset but it will be shown in unusual or infrequent items not as a part of discountinued business operation beacuse as per the above definition you are not moving out of the business or changing line of the business just selling the asset and continue the same business

Hope this helps

#5

Ok that makes sense, I understood. Thank you so much for the explanation!!!