Disclosing disposals: The challenges of subjective judgments

A year has now passed since the FASB revised its criteria for discontinued operations and the disclosure for disposals. Given that the standards took effect just this year, some companies are very much in the thick of deciding how to apply these criteria. There are a number of factors at issue here, not the least of which is the likely desire by stakeholders for more information about disposals that no longer qualify for discontinued operations treatment.

There are four core elements of the new standard (Update No. 2014-08). First, under the old standard, a discontinued operation was the disposal of a component for which operations and cash flows were eliminated. This was a lower threshold.  The new guidance dramatically raised that threshold, defining a discontinued operation as a disposal constituting a strategic shift that has a major effect on operations and financial results. Thus, companies now face a two-step test: (1) whether the disposal represents a strategic shift; and (2) whether that shift will have a major effect.

Second, while narrowing the definition of discontinued operations, FASB increased the amount of disclosures that must be made regarding them.  For example, companies must now provide more details about earnings and balance sheet accounts, total operating and investing cash flows, and cash flows resulting from continuing involvement.  Moreover, companies are now obligated to provide a comparative balance sheet presentation for discontinued operations.

Third, the new guidance provided that (a) the failure to eliminate the significant operations and cash flows of a disposed component from an entity’s ongoing operations after a disposal, or (b) having significant, continuing involvement with a disposed component, no longer precludes a disposal from being presented as a discontinued operation. Consequently, while the definitional change of “discontinued operations” will decrease the amount that are presented as such in financial statements, this second change will make up some of that lost ground by increasing the breadth of disposals that now qualify.

Fourth, recognizing that fewer disposals will be presented as discontinued operations, the FASB created a new requirement: entities must now make certain disclosures about “significant” disposals that do not meet the revised threshold.  This requirement includes disclosing the pretax profit or loss of a disposed component.

As you can see, the new guidance introduces new concepts. The analysis is subjective and considers company-specific factors involving strategy to determine if a strategic shift occurred and assessment of key metrics such as revenue, income, assets or EBITDA to determine if the change will have a major effect. The FASB provided some examples to help with the assessment, but ultimately these judgment calls boil down to corporate intent and impact analysis – no simple tasks.

It is also likely that in certain instances, investors will want greater transparency into disposals that would have qualified as discontinued operations under the old standard but now don’t. Having been used to fairly detailed information of the impact these individual disposals had on a company’s financials, investors will not want to lose all of it. Companies will need to determine if they want to make supplemental disclosures, while keeping in mind that depending on how they presents this information it may be a non-GAAP measure.

 For more on this topic, view PwC’s In the Loop piece: Selling part of your business? New rules for reporting disposals.