Accounting for Discontinued Operations

In financial statements, discontinued operations must be disclosed on the income statement in the period in which it occurs. Although a discontinued operation is considered a contingency, the guidelines for revealing this information is not the same as for other “likely” contingencies. It is only the amount of gain or loss that is “contingent”

A contingency is an amount dependent on another transaction or event. When management makes the executive decision to sell a portion of the business, often they don’t even know whether the sale will result in a gain or a loss. The exact amount isn’t usually known until the transaction is final.

As a result of the unknown, a contingency has been created by the existence of the discontinued operation. On the income statement, gains or losses on discontinued operations are reported in the section that follows income from continuing operations and precedes extraordinary items.

When the company sells or discontinues a portion of the business, there are tax consequences. When the company experiences a gain, typically, there are additional taxes to be paid. When the company experiences a loss, there are often tax savings to be had. Regardless, these tax consequences must be disclosed.

For potential and current investors, when a discontinued operation is disclosed, it is key to not only pay attention to the net income. The reason for this is that clearly a section of the business is no longer  contributing to the company’s earnings. Therefore, the income from continuing operations becomes the supreme figure of importance when trying to predict the future earning capacity of the company.