02. Discontinued Operations: Accounting & EPS Impact

By Jay

🔹 Introduction to Discontinued Operations

Discontinued operations represent a component of an entity that:

  1. Represents a separate major line of business or geographical area, or
  2. Is part of a single coordinated plan to dispose of such a component, or
  3. Is a subsidiary acquired exclusively for resale

➡️ Under ASC 205-20, these are reported separately from continuing operations on the income statement, with results shown net of tax.

📄 Reporting Requirements (ASC 205-20)

For a discontinued operation, entities must present:

  • ✅ Separate line item on the income statement
  • ✅ Major classes of revenues and expenses
  • ✅ Pre-tax profit or loss
  • ✅ Income tax expense or benefit
  • ✅ Gain/loss on disposal, if applicable

🧮 EPS Calculation

Basic EPS

  • Continuing operations:

    Income from continuing operations−Preferred DividendsWeighted Average Shares\frac{\text{Income from continuing operations} - \text{Preferred Dividends}}{\text{Weighted Average Shares}}

  • Discontinued operations:

Income from discontinued operationsWeighted Average Shares \frac{\text{Income from discontinued operations}}{\text{Weighted Average Shares}}

Diluted EPS

  • Total diluted EPS:
Net Income−Preferred DividendsWeighted Avg Shares+Potential Dilutive Shares \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Avg Shares} + \text{Potential Dilutive Shares}}

➕ Potential dilutive shares include:

  • Stock options
  • Convertible securities
  • Warrants

📌 Treasury Stock Method:

  1. Assume options/warrants are exercised
  2. Use proceeds to repurchase shares at avg market price
  3. Incremental shares added to denominator

📊 Example: Company XYZ

Given:

  • Net income from continuing ops: $500,000
  • Loss from discontinued ops: $(150,000) (net of tax)
  • Weighted avg shares: 100,000
  • 20,000 options at $30/share
  • Average market price: $50

▪ Summary Table:

ComponentAmount
Income from continuing ops$500,000
Loss from discontinued ops$(150,000)
Net Income$350,000

✅ Basic EPS

  • Continuing ops: 500,000 ÷ 100,000 = $5.00
  • Discontinued ops: -150,000 ÷ 100,000 = $(1.50)
  • Net EPS: 350,000 ÷ 100,000 = $3.50

✅ Diluted EPS (with treasury stock method)

  1. Proceeds: 20,000 × $30 = $600,000
  2. Shares repurchased: 600,000 ÷ $50 = 12,000 shares
  3. Incremental shares: 20,000 - 12,000 = 8,000
  4. New denominator: 100,000 + 8,000 = 108,000
  • Continuing ops: 500,000 ÷ 108,000 = $4.63
  • Discontinued ops: -150,000 ÷ 108,000 = $(1.39)
  • Net EPS: 350,000 ÷ 108,000 = $3.24

✅ Common Exam Points

  1. 📌 Discontinued operations = Net of tax
  2. 📌 Both basic & diluted EPS must be shown
  3. 📌 Prior periods must be restated to reflect discontinued ops
  4. 📌 Gain/loss on disposal included in discontinued ops
  5. 📌 No separate line in Cash Flow Statement for discontinued ops required

📢 Note:
ASU 2014-08 made the criteria stricter. Now, it must represent a strategic shift that has a major effect on financial results.