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New discontinued operations guidance de-clutters reporting

While large valuation acquisitions of entire companies (for example, Facebook acquiring WhatsApp for $19 billion) grab the headlines, the majority of the acquisitions are for just a division or segment of a business, and they have much smaller price tags and light media coverage.

Some of those deals are notable. Earlier this year, Nokia, which was once the dominant mobile handset maker in the world, sold its handset division to Microsoft for $7.5 billion. But most of them fall under the radar, justifiably. Each month in Silicon Valley, hundreds of high tech and biotech companies are making business and market decisions about when to sell off or close operations of a segment of their business. Reporting on these divested businesses is a time-consuming task that results in information that is often of little value to investors and can actually be confusing.

In response, the Financial Accounting Standards Board (FASB) recently updated guidance to strike a balance between the materiality of a discontinued operation and the details that companies need to provide about it. This revised standard (Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity) is expected to result in fewer disposals being presented as discontinued operations. To qualify as a discontinued operation, a component or group of components must represent a “strategic shift” that has (or will have) a major effect on an entity’s operations and financial results. These can include the following:

  1. A major line of business
  2. A major geographical area
  3. A major equity method investment
  4. Other major parts of the entity

The guidance is to be applied prospectively to all new disposals of components and new classifications as held for sale beginning in 2015 for most entities, with early adoption allowed in 2014.

In the regular course of business, companies frequently evaluate how all their brands and segments align with their strategic plan. They may find some acquisitions that did not pan out, or segments or product lines that are being deemphasized or no longer fit with the strategy of the company. Closing or selling off such a division lets the company mitigate losses or accumulate additional capital that can be invested in its core businesses.

The same logic happens at your favorite neighborhood restaurant. Customers’ food preferences shift over time and items disappear off the menu when seasonal specials or improved offerings are available. Why keep an item on the menu that hardly anyone buys? Restaurant owners know they have to constantly improve operational efficiency and decrease their food costs associated with waste.

When companies in any industry give a contemplative eye to their own menu choices, so to speak, they may see how a paring down could lead to improved operations, lowered expenses, and greater efficiencies. The FASB’s new guidance uses the same definition for a component of an entity as before. That is, a component comprises operations and cash flows that can be clearly distinguished—operationally and for financial reporting purposes—from the rest of the entity. However, the new guidance requires that, in order to be reported, a disposal of a component represents a strategic shift that has or will have a major effect on an entity’s operations and financial results. This is a key distinction.

What this means is the new guidance provides a lighter financial-reporting burden when small divestitures occur. This is a rare “phew” finance teams rarely feel after seeing new accounting guidance.  Another significant improvement in the new guidance is the timing of disclosure—just because a company has continuing involvement with a disposed component doesn’t mean it has to put off reporting it as a discontinued operation. This change could result in easier negotiations for the company that is in the process of divesting a piece of its business but has a need to assist in the transition (for example, if the acquiring company still needs a manufacturing facility for a period of time).

Of course, companies should be mindful that new disclosures are required for disposals that don’t meet the new definition of a discontinued operation if they are material. And companies still have to give thoughtful consideration to what the FASB means by “strategic shift.” Does the company’s board view the disposal as indicative of an overhaul? Would giving it the heave-ho signify a big change in the direction for the company and be something investors would really want to know about? Would the marketplace care? Those are some key questions to ask. While the answers are going to vary from company to company, how any one company interprets the guidance should be consistent and well documented.

With the new guidance, companies can properly manage their business by shedding previously acquired companies and fine-tuning their operations without the clutter of reporting these activities if they are not material to their operations.

Steve Jackson, a member of the RoseRyan dream team, has expertise in the areas of revenue recognition, SOX, systems implementation, budgeting, financial analysis, and process improvements, among others. He has worked at public accounting firms and corporate finance departments for over 30 years.

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