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?
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.