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A component is defined in ASC 205-20-20.

Definition from ASC 205-20-20

Component of an entity: A component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. A component of an entity may be a reportable segment or an operating segment, a reporting unit, a subsidiary, or an asset group.

We do not believe that a component can be at a lower level than an asset group because, in order to be a component, the cash flows must be clearly distinguishable from the rest of the reporting entity.
For a component to qualify as a discontinued operation at the balance sheet date, it must meet the criteria in ASC 205-20-45-1B which states the component must either be disposed of (e.g., through sale, abandonment, or spin-off), or meet the held-for-sale criteria of ASC 205-20-45-1E. It must also represent a strategic shift that has (or will have) a major effect on the reporting entity’s financial results.
Long-lived assets may be disposed of individually or as part of a disposal group. The guidance defines a disposal group.

Definition from ASC 205-20-20

Disposal group: A disposal group for a long-lived asset or assets to be disposed of by sale or otherwise represents assets to be disposed of together as a group in a single transaction and liabilities directly associated with those assets that will be transferred in the transaction. A disposal group may include a discontinued operation along with other assets and liabilities that are not part of the discontinued operation.

Question FSP 27-1 addresses whether an entity can consider an operation a component when the entity sells the operation but retains certain assets.
Question FSP 27-1
Can a reporting entity that sells an operation but retains certain assets associated with the operation (e.g., working capital or a facility) consider the operation a component of the reporting entity?
PwC response
It depends. Although the retained assets would not be part of the disposal group, the operations and cash flows associated with the assets to be sold may still constitute a component of a reporting entity as defined in ASC 205-20-20. In that situation, the results of operations of the component would be classified as discontinued operations provided the conditions of ASC 205-20 are met.

A reporting entity’s assessment of whether a component qualifies for discontinued operations reporting should occur when the component initially meets the criteria to be classified as held for sale in accordance with ASC 205-20-45-1E. The held for sale criteria in ASC 205-20-45-1E are the same six criteria as those set forth in ASC 360-10-45-9 (see FSP 8.6.2). Changes in circumstances that occur after the balance sheet date, but prior to issuance of the financial statements, should not be considered in evaluating whether the component would be classified as held for sale at the balance sheet date.
For abandonments, spin-offs, and exchanges, the assessment should take place when the component is disposed of. If a reporting entity has a disposal strategy that involves the “run-off” of operations (e.g., the reporting entity will cease accepting new business but will continue to provide services under existing contracts until they expire or terminate), discontinued operations should not be reported until substantially all operations, including run-off operations, cease.

27.3.1 Strategic shift and major effect

A component (or a group of components) of a reporting entity that is disposed of or meets the criteria to be classified as held for sale should be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on a reporting entity’s operations and financial results. ASC 205-20-45 provides examples of what may qualify as a strategic shift.

Excerpt from ASC 205-20-45-1C

Examples of a strategic shift that has (or will have) a major effect on an entity’s operations and financial results could include a disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of an entity.

A reporting entity’s assessment of whether a disposal of a component represents a strategic shift that has (or will have) a major effect on its operations and financial results should consider quantitative and qualitative factors. No single factor is determinative. As such, the less significant a component is from a quantitative perspective, the more persuasive the qualitative evidence should be to support discontinued operations reporting.
The assessment of what qualifies as a strategic shift is based on qualitative and quantitative factors specific to the reporting entity. For example, a reporting entity that only operates in the Northeast region of the US may conclude that each state represents a major geographical area. In contrast, a multinational reporting entity may conclude that each continent represents a major geographical area.
A component may be a reportable segment, an operating segment, a reporting unit, a subsidiary, or an asset group. Disposing of an entire reportable segment is a strong qualitative factor supporting that a strategic shift has occurred. A reporting entity should consider all relevant factors, including the extent to which the component’s performance was previously disclosed in MD&A, earnings releases, and other communications, in determining whether the disposal represents a strategic shift.
Once a reporting entity determines that a disposal constitutes a strategic shift, it must determine whether the disposal has had (or will have) a major effect on the reporting entity’s operations and financial results for the disposal to be considered a discontinued operation. A reporting entity should consider key financial metrics when evaluating the quantitative impact of a disposal, including assets, net assets, revenues, operating income, pretax income, net income, operating cash flows, and key non-GAAP measures. In terms of the evaluation period, we believe the emphasis should be placed on the most recently completed, current, and next annual reporting periods. The guidance does not provide any “bright lines” on what qualifies as a major effect. However, it does include five examples:
  • The sale of a product line that represents 15% of total revenues
  • The sale of a geographical area that represents 20% of total assets
  • The sale of all of one type of a reporting entity’s store formats that historically provided 30 to 40% of the reporting entity’s net income and 15% of current period net income
  • The sale of an equity method investment that represents 20% of the reporting entity’s total assets
  • The sale of 80% of a product line that accounts for 40% of total revenue, but the seller retains 20% of its ownership interest

Significant continuing involvement with or continuing cash flows related to a disposed component does not preclude a reporting entity from presenting those components as discontinued operations. However, reporting entities should consider the nature and extent of continuing involvement in evaluating whether there has been a strategic shift that has (or will have) a major effect on their operations and financial results.
A discontinued operation may be a single component or a group of components. When a reporting entity disposes of multiple components, each component should generally be evaluated individually, and only components that meet the criteria for discontinued operations treatment should be reported as discontinued operations. However, there may be circumstances when a group of components should be evaluated together to determine whether the criteria for discontinued operations have been met. Such circumstances may include instances when multiple components are being sold under a single disposal plan, in a single transaction, or to a single buyer.
Example FSP 27-1 addresses when the disposal of two components should be combined for purposes of determining whether they constitute a discontinued operation.
EXAMPLE FSP 27-1
Evaluating group of components in a single plan of disposal
In the first quarter of 20X1, FSP Corp’s board of directors approved the sale of a major business line, which consists of Component A and Component B. The business line to be sold is a reportable segment. FSP Corp announced the disposal plan as a single plan but will sell Component A and Component B in two separate transactions to different buyers. While neither Component A nor Component B would meet the criteria for discontinued operations individually, together they represent a strategic shift that has a major effect on FSP Corp’s operations and financial results. Based on the held-for-sale criteria in ASC 205-20-45-1E, Component A was classified as held-for-sale beginning March 31, 20X1, while Component B was classified as held-for-sale beginning June 30, 20X1.
Should Component A and Component B be presented as discontinued operations and, if so, in which period is such classification appropriate?
Analysis
As Component A and Component B were part of a single plan of disposal and both met the held-for-sale criteria within a short period of time, we believe FSP Corp should present Component A and Component B as discontinued operations as of June 30, 20X1, as this is the date on which both components comprising the disposal plan were considered held for sale and therefore met the criteria to be classified as discontinued operations.

If a plan of disposal involves one component to be disposed of through multiple disposal transactions, discontinued operations is only appropriate at the point-in-time that the entire component meets the criteria for discontinued operations. If significant time passes between the disposals of portions of the component (e.g., a year or more), it may be difficult to conclude that the disposals are part of a single component.
Reporting entities that prepare subsidiary financial statements should separately evaluate whether a strategic shift has occurred and whether it has (or will have) a major effect on the reporting entity’s operations and financial results at each level. A subsidiary may reach a different conclusion than its parent.

27.3.1.1 Acquired business that qualifies as held for sale upon acquisition

Any business or nonprofit activity that upon acquisition meets the held for sale criteria is required to be presented as a discontinued operation regardless of whether it represents a strategic shift that has (or will have) a major effect on a reporting entity’s operations and financial results. The held-for-sale criteria in ASC 205-20-45-1E(d) is the only criteria required to be met at the acquisition date, but the remaining criteria should be probable of being met within a short period of time following the acquisition date, which is usually within three months.
The objective of this requirement is to include in discontinued operations those businesses that will never be considered part of a reporting entity’s continuing operations.
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