Staff at the Securities and Exchange Commission offered a bit of advice to companies trying to sort out when a particular disposal should be characterized in financial statements as a discontinued operation. If the financial impact is meaningful, and you’ve made a big deal about that particular metric in the past, that should be taken into account.
Barry Kanczuker, associate chief accountant at the SEC, said during a recent national accounting conference that the new standard from the Financial Accounting Standards Board on when to treat a particular disposal as a discontinued operations doesn’t provide bright lines or safe harbors that would make the analysis clear cut. Under the new guidance, which took effect in 2015, companies would present a disposal as a discontinued operation if it represents a strategic shift that has a major effect on an entity’s operations and financial results, he said.
FASB developed the guidance to answer concerns that too many asset disposals had to be classified as discontinued operations under the old rules. Experts generally agree that the new standard will result in fewer asset sales being characterized as discontinued operations, but it also would require companies to apply more judgment to the analysis.
“So how does one determine what represents a strategic shift that has or will have a major effect?” Kanczuker asked. “I would observe that the standard requires judgment to determine whether a disposal meets the revised definition for a discontinued operation.” The standard provides plenty of examples, he said, but they are not determinative.
“We have heard suggestions that the quantitative factors included in the examples are meant to create thresholds by which to determine whether a disposal represents a strategic shift that has a major effect on the entity’s operations and financial results,” said Kanczuker. “In my view, the thresholds are illustrative and do not establish bright lines or safe harbors.”
Even further, Kanczuker said, companies will have to apply judgment to what constitutes a relevant financial result. “I believe that judgment is required to determine which financial results are indicative of a strategic shift that has a major effect,” he said. Certain “primary metrics” that are prominently presented in financial statements and communicated to investors are obvious: revenue, total assets, and net income, for example.
Beyond those, companies should look at financial results that might be relevant to their particular investors, especially results that have been regarded as important historically in communicating operating and financial results to investors, Kanczuker said.
“The guidance indicates a need to evaluate the totality of the evidence, and there is no single financial metric that is determinative in concluding that a disposal had a major effect on the entity’s operations and financial results,” said Kanczuker. “The less significant a financial impact the disposal has on an entity, the stronger the qualitative evidence needs to be. Consider the prominence and consistency with which the disposed component and related qualitative factors have been discussed within periodic filings.”