Discontinuing Operations - Case Study Example

March 12, Discontinuing Operations In accounting for discontinued operations, ASC requires that operating income from discontinued operations and any gains or losses from their sale be segregated in the income statement, since these activities will not contribute to future income and cash flows. As in the case of extra ordinary items, this segregation makes the reported information more useful for analysis. To qualify for treatment as discontinued operations, the assets, results of operations, and investing and financing activities of a business segment must be separable from those of the firm.

ASC states that the separation must be possible physically and operationally and for financial reporting purposes. At the measurement date, the firm will accrue any estimated loss from operations during the “phase-out period, that is, from the measurement date of the disposal date, and any estimated loss on sale or disposal. However any gain on disposal can be reported only after disposal, that is when realized (Accounting Standards Codification. Implementation Guidance and Illustrations 1).

At end of the year the income statement reporting of discontinued operations should reproduces the income statement and partial footnotes of the Pit Stop centers. The income statement should show the two components of the segment have been excluded from reported sales and income from continuing operations. This means that reported sales and earnings will be restated to exclude the discontinued segment. The disclosure note should also provide summary disclosure of the net assets and operating results of the discontinued segment.

However, any gain or loss from the sale of a portion of a business segment must be reported pretax as separate component of income from continuing operations rather than as a discontinued operation. Firms are encouraged to disclose separately the affected assets and liabilities on the balance sheet. However, the income or loss from operations from the beginning of the year to the measurement date is not always segregated on the income statement. Some firms provide footnote disclosure of this datum for all years presented.

The income or loss during the phase-out period and the gain or loss on sale or disposal is included in income from continuing operations(Accounting Standards Codification. Disclosure 1). Auto world had two different segments: the Auto Boyz Center and the Pit Stop Centers’. The company submits their financial statements as per the ASC. As per the ASC, the company discloses its financial reporting about different statements (Accounting Standards Codification 2). It has been found in the financial statements of company that the company’s net sales and operating earnings are mentioned Segment-wise.

As per the ASC, the company also meets the criteria and it has to reveal the cost associated with the retirement or disposal of assets. As it winds up the Pit Stop Centers, the company management has to meet the requirement for presenting the cost due to termination of the operating leases and the other cost associated therewith. The Pit Stop Stores are the long-lived assets of the company as they include the buildings and some other property. Therefore, the company has to meet the criteria of ASC.

The division had a negative cash flow of 172m in the year 2006, it is estimated that it will increase free cash flows by 58 million in the year 2008 and 67 million annually. If we take the cost of capital the company to be 10%, then we will estimate the significance of the cash flows of the company. The present value of this investment will be, present value will be calculated as Pv= + Pv= +=722.73m The return is greater as compared to the restructuring cost of 52 million. Conclusion and recommendation In addition, the company should make disclosures nonrecurring cost related to restructuring.

The note should show that the 2007 restructuring cost of was $52 million. Note that these non-recurring items are reported pretax a part of the income from continuing operations. At this point, it should be noted that what happened is merging divisions of the company and not discontinuing operations. For transactions to qualify for classification as discontinued operation, some condition ought to meet: Income and cash flows does not exist at all in books of the reporting entity The operations ceased to exist after disposal.

This is clear indication that Pit Stop centers is not a discontinued operation but a merged business. This is why the restructuring costs should be reported Other information In our case, the accounting treatment required is accounting for merging divisions, which is different from discontinuing operations. The merging of two divisions is a process that requires merging of the two systems of operation that a company operates in the hope of serving their target customers. The aim of the merger is to be able to meet the needs of a growing number of customers in a more competent approach and eliminate unnecessary costs.

In addition, the management must recount pertinent conditions and events which gave rise to assessment and when they are likely to occur; and if possible, to offer an estimate. In addition, the possible effects of the events and conditions ought to be well known as well as if there is a possible discontinuing of operations. The management must also be at all times ready to evaluate the significance of conditions and events and possibly mitigate them. Finally, the management must be able to evaluate and implement mitigation plans and also offer information about the recoverability of the assets and liabilities of the entity.

The accountant when preparing financial statements, should assess an entity’s ability to continue as a going concern and if not considered, a disclosure to be made about the same. The management benefits by knowing which decisions to make about the business future hence knowledge of going concern is very crucial. Such decisions may be in form of uncertainty regarding events, material, or size of the business, which the management deals with on a day-to-day basis(Accounting Standards Codification.

Reporting Discontinued Operations 1). In evaluating the value of liquidation of a company basing on the principle of going concern, a number of approach are followed and these include discounted cash flow approach, formula approach, market approach, and asset approach. The asset approach depends on the organization’s adjusted book value where the fair market value of liabilities and assets are substituted with the stated values of liabilities and assets. This approach is helpful in the evaluation of a company that has extensive undervalued assets.

However, this approach is not recommended by ASC in determining the value of an organization as a going concern (Accounting Standards Codification. Other Presentation Matters 1). Other approaches are recommended where they consider time value of money in making predictions and so they are recommended for the current evaluation where global business environment is in crisis. These approaches used in determining going concern may require adjustments to account for qualitative factors and special conditions such as non-operating assets, key person risk, none recurring loses and gains, and reasonable management compensation.

Works Cited Accounting Standards Codification. Disclosure. Discontinued Operations. Web March 12, 2012 Accounting Standards Codification. Implementation Guidance and Illustrations. Discontinued Operations. Web March 12, 2012 Accounting Standards Codification. Other Presentation Matters. Discontinued Operations. Web March 12, 2012 Accounting Standards Codification. Reporting Discontinued Operations. Discontinued Operations. Web March 12, 2012