ASC 205 -20 calls for the reporting of any discontinued operations for the components of an entity. A component, in this case, comprises cash flow that can be distinguished both operationally and for purposes of financial reporting from the rest of the entity. The legal aspect of discontinued operations, in this case, does not matter. The financial information for the component or entity should be easily available (Cheney, 2018). Statement 144 of the current FASB defines a discontinued operation as a component that has been classified as for sale or disposed of provided that the cash flows and operations have been eliminated by the transaction and the entity will not have any significant involvement in future. IFRS 5 identifies components with discontinued operations as having different lines of business or geographical location and is part of a coordinated plan to dispose of the business.
Overview of Previous GAAP
In the previous GAAP, the discontinued operations are shown on the income statement net of tax basis. Before the ASC 250 was adopted, GAAP used the cumulative effect of the changes in the accounting practices that also involve the presenting the statement net of tax. The cumulative effect of accounting change was also eliminated by FAS 154. Currently, a company with a change in the accounting principles should restate its retained earnings for effects of an accounting change and not as a cumulative effect on the income statement. Initially, GAAP provided that discontinued operations be presented below the income of an entity accrued from continued operations and should be net of the tax effect (Dickins, Reilly, McCarthy & Schneider, 2017).
Delegate your assignment to our experts and they will do the rest.
Presentation of Financial Statement
Before the adoption of ASU 2014-08 GAAP used ASC 205 on the presentation of financial statement that stated that the results of operations for part of an entity that has already been disposed or help for sale will be reported in discontinued operations if their operations and cash flow will be or have been eliminated from continuing operations of the entity. Similarly, the unit will not have any continuing involvement in operating the component once it has been disposed of (Dickins, Reilly, McCarthy & Schneider, 2017).
Change in the Definition of Discontinued Operations and Expansion of its Disclosure
A discontinued operation is defined as a component of an entity that is part of a separate line of business or even geographical location that has been disposed or held for sale according to the criteria in paragraph 360-10-45-9. A discontinued operation can also be a business that during its acquisition met the criteria in the said paragraph (Weiss, 2013). The definition for discontinued operation and the reclassification of assets as discontinued operations has continued to change over time. According to the APB opinion 30 on reporting the results of operations, noted that only dispositions from a business segment can qualify for discontinued operations. The section defines a business segment as a customer class or major line of business which is different from the previous definition that used component of an entity (Dickins, Reilly, McCarthy & Schneider, 2017).
Qualification for Discontinued Operation
Discontinued operations must meet the cash flows including recognition of future revenues to be recognized as such. FASB requires that an entity must provide all information of significant components that are disposed of or held for sale. The new guidelines, however, limit the number of reported discontinued. An operation initially qualified as a discontinued operation if it meets the following conditions as established by the FASB. The component has already been disposed or is help for sale and classified as such in the books of account. The operations and cash flows of the identified component must be removed or will be eliminated from the operations of an entity following their disposal. Once the transaction is complete, the entity will not have continuing involvement in the operation of the disposed component following the transaction. The last two criteria were however eliminated by the new guidelines that require discontinued operation treatment for the sale of a component that represents a strategic shift that is likely to have a significant impact on the financial results of an entity or its operations (Morris & Velanand, 2014).
Disclosure Requirements for Transactions that Meet the Definition of Discontinued Operation
An entity must disclose in the period the operating and invest cash flows, any depreciation, and amortization, any capita; expenditures, operating and investing noncash items that are connected to the discontinued operations. Such presentation requirement indicates a significant shift from earlier guidelines. All transactions that meet the definition of discontinued operation must be disclosed in the books of account for an entity in the period under which such an operation was discontinued. The fair market value should be used and any proceeds must be recorded in the statements of an entity. Assets that have been discontinued from operations should have their register closed and any proceeds from them should be reported once the transactions are complete (Lord & Saito, 2014).
The Act of Classification Thinking
Shifting Losses from Continuing Operation to Discontinue operations
Entities have been shifting their transactions from the continuing operations to the discontinued operation. By shifting its losses or even expenses, companies try to correct a negative effect or to display better performance in its books of account. Such actions improve the income from continuing operations which is a benchmark for measuring the performance of an entity. It acts as the starting point for business measurements including cash flows and EBITDA. By reducing and eliminating discontinued operations and other extraordinary items, FASB was wanted to deal with classification shifting (Lord & Saito, 2014)
Classification Shifting to Alter the Earnings and Stock Value
Entities shift losses and expenses to the discontinued operations yet they retain income and other gains in the continuing operations. Companies have engaged in classification manipulation to improve their performance hence increase the value of their stock. Companies that report losses in discontinued operations record such items out of the income of the ongoing operations. Such a move affects the operating income of a company, the income from the continuing operations and the core earnings. Increase in the earnings of a company drives the stock prices f a company. The value of the stock can thus increase by a substantial amount depending on the value of the losses or expenses that have been shifted to discontinuing operations. Such an increase in the stock value takes place without altering the net income of an entity (Lord & Saito, 2014).
Criticism of Discontinued Operations
Companies use discontinued operations to shift some of their losses from continuing operation to discontinued operations thus reporting higher incomes and improved sock values. Similarly, companies engage in classification shifting as it does not expose the top management as the net income of the company is not altered. The FASB has continued to attack discontinued operations by reducing the transactions that qualify for discontinued operations. The ASU 2014-08, for instance, restricts the scope of transactions that qualify for such treatment.
References
Dickins D., Reilly C., McCarthy M. & Schneider D., (2017). Reporting of Discontinued Operations - The CPA Journal . The CPA Journal . Retrieved 28 February 2018, from https://www.cpajournal.com/2017/02/15/reporting-of-discontinued-operations-past-present-and-future/
Emery J., (2014). Asu 2014 08 Changes The Way Discontinued Operations Are Reported | Library | Resources . (2018). Bnncpa.com . Retrieved 28 February 2018
Lord, R., & Saito, Y. (2014). Performance Before and After Discontinued Operations. SSRN Electronic Journal . http://dx.doi.org/10.2139/ssrn.2538576
Morris, R., & Velanand, A. (2014). FASB’s New Guidance to Amend Discontinued-operations Reporting . Wall Street Journal . Retrieved 28 February 2018, from http://deloitte.wsj.com/cfo/2014/05/02/fasb-issues-asu-to-amend-discontinued-operations-reporting/
