Definition: Discontinued operations are essentially the portion of an entity that no longer functions within the core business units or product lines of the entity and is reported separately on the income statement.
What Does Discontinued Operations Mean?
What is the definition of discontinued operations? While these activities may still generate profit for a business, they are classified as discontinued operations within the financial statements of the entity to ensure external users do not inappropriately evaluate the profitability of the entity’s continued operations. Businesses must follow a set of strict accounting rules that require them to disclose the details of all ceased operations, as well as any impact on the entity’s financial statements.
Companies often cancel product lines, dispose of equipment, sell market segments, and shift their business models. All of these structural changes result in discontinued product lines, profit centers, or business units.
Businesses must present a clear definition of the portion of the business that is discontinued, and a clear indication by management that the discontinued operation is absolutely no longer part of the entity’s core business, or continued operations in the financial statements. This helps creditors and investors what is reoccurring and what activities will end.
Let’s take a look at an example.
Let’s say a company sells 20 different models of telephones, and the products are divided into 2 separate business units: the Rotary Phone Business Unit and the Wireless Phone Business Unit. Each of the business units sells 10 models of telephones, and each model is clearly defined into their respective business units.
The telephone industry has advanced greatly over the years, and the company has experienced a major decline in sales as well as deteriorating profit margins within the Rotary Phone Business Unit. This is attributed to aging technology, and the fact that wireless phone technology has become much more affordable to the overall market.
As a result, the board of directors and management of the company have decided to sell or dispose of all aspects of the Rotary Phone Business Unit. They’ve made the strategic decision to only focus on the Wireless Phone Business Unit, and all aspects of Rotary Phone Business Unit, including all 10 models of telephones within the business unit are considered discontinued. The company will disclose this information within the financial statements, and the company will clearly define all financial impacts of the Rotary Phone Business Unit within the discontinued activities section of the financial statements (including impacts to the Balance Sheet and Profit & Loss Statement).
Define Discontinued Operations: Discontinued operations means is income reported separately from operating income on the income statement because it consists of earnings from a segment of the business that no longer exists.