Discontinued Operations and Extraordinary Items - Online Tutor, Practice Problems & Exam Prep

Discontinued operations and extraordinary items are non-recurring elements on the income statement. Discontinued operations occur when a company exits a significant part of its business, reported separately at the bottom of the income statement, net of tax. Extraordinary items, such as unusual gains or losses, also appear separately and are infrequent events, like a warehouse fire. Both are shown as single amounts to maintain clarity in financial reporting, ensuring investors can easily discern ongoing business performance from these exceptional occurrences.

Discontinued Operations

So let's quickly discuss two non-recurring items that appear on our income statement: discontinued operations and extraordinary items. The first one here, discontinued operations, occurs when the company plans to exit a major component of its business, okay? It's not closing down its business altogether, it's just discontinuing some operations. Imagine there's a computer company that sells computers and service repair contracts. They sell both the computer and then offer, "Hey, we'll repair the computer if you pay for this contract." But then decide, "You know what? The service contracts aren't making us that much money; let's discontinue service contracts and just sell computers." It will need special presentations for these discontinued operations. However, I want to note that it's beyond the scope of this class; we're not going to get into the details of discontinued operations. The most important thing you really need to know about it is that it appears on the income statement, and we show it separate from our regular operations. We will show our income from our continuing operations just as we usually do. We'll show our revenue, our cost of goods sold, our operating expenses, all of that. But then we'll show our discontinued operations separately, at the bottom.

The first thing we want to note is that both discontinued operations and extraordinary items are non-recurring items. We're not expecting these things to show up on our income statement every year, okay? They are not a persistent activity of the business; we are expecting these discontinued operations to stop very soon. And when we show them on the income statement, like I said, we won't mix the sales of the service contracts with the sales of the computers. No. We need to separate everything related to the discontinued operations, and what we're going to do is show it as a single amount, net of tax. It will appear at the bottom of the income statement and will be shown as one item, "Income from discontinued operations, net of tax 500," whatever it is, right? Or loss, we might have a loss from these discontinued operations, and it'll just be shown at the bottom. We're not going to show all the details; those details are left for the footnotes. And on the balance sheet, we're also going to show it separately. We're not going to net the discontinued operations assets and liabilities as a single amount. We'll show, "Hey, discontinued assets" and these assets here, and the discontinued liabilities, they'll be shown separately from our regular assets and liabilities. Okay? They're still going to show up there. The main thing you want to know is what a discontinued operation is: it's something that we're not going to continue doing in the future, and that we show it as a single amount, net of tax, at the bottom of our income statement. We'll have an example of an income statement at the bottom of the sheet where we'll go over this one more time. Alright? In the next video, let's talk about extraordinary items.

Extraordinary Items

Alright, so when we talk about extraordinary items, these are going to be extraordinary gains and extraordinary losses and these come up from items that are unusual and infrequent. Okay? So an extraordinary loss would be from something that's unusual and infrequent. So what would be an example of one? Well, the warehouse caught on fire and we had inventory that was burned up, right? We're not expecting to have inventory warehouse fires every year, right? This should be a non-regular, non-recurring event. And it should be extraordinary, right? Unusual and infrequent. And an example of an extraordinary gain would be a gain on the sale of a discontinued operation. More often when you talk about extraordinary items, we're talking about an extraordinary loss, but every now and then, we'll have an extraordinary gain. This should be unusual and infrequent, right, when we sell a portion of our business. We're not in the business of buying and selling portions of our business. No. This is going to be unusual and infrequent, so it will be shown separately. Okay?

So just like we said with discontinued operations, the calculations here are also beyond the scope of this class, okay? The calculations for extraordinary items are also beyond the scope of this class, but we're going to talk about just a few things just like we did with discontinued operations. We have to note that these are non-recurring, right? We're not expecting these extraordinary items to happen every year. It's not a persistent activity of the business. We're not in the business of having warehouse fires or selling discontinued operation segments of our business. No. It's non-recurring. It should only happen one time on our income statement.

And I want to make a note that these extraordinary items in the real world, there are so few cases of it. It rarely shows up on any income statement, okay? And the other thing is, just like discontinued operations, we're going to show them as a single amount net of tax, and they're going to be shown at the bottom, below all of our income from continuing operations. We're trying to separate these things so that they don't muddle up our income statement. We want to show our income statement for what our business is really doing and then these weird things that investors still want to know happened, but we don't want it to muddle up our information, so we put it at the bottom, separately. Okay?

So let's go ahead and peek at this income statement real quick for Verizon Communications, and you'll see we've got our operating revenues, everything we're used to right here, right? Income from continuing operations, sorry, we're going to include a little more there, everything from here to there, that's all continuing, right? This is all the regular part of our business and then notice what we show at the bottom. We show our discontinued operations, net of tax, and we show an extraordinary item, net of tax. Right? So even though there's not so much information here, I'm sure you could look into the notes of the financial statement. After we show the financial statements, there will be more information about these discontinued operations and these extraordinary items. But notice that we just show them as one amount for each of them, right? We show an amount for discontinued operations, an amount for extraordinary items, and then we get to our net income, just like we're used to. Okay?

So they're shown net of tax and as a single amount. Cool. That's about it. We don't need to go into so much detail about these. Just remember that they're non-recurring and they show up here at the bottom of the statement. Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What are discontinued operations in financial accounting?

Discontinued operations refer to a component of a company's business that has been disposed of or is classified as held for sale. This component must represent a separate major line of business or geographical area of operations. On the income statement, discontinued operations are reported separately from continuing operations to provide a clear distinction between ongoing business activities and those that are being phased out. They are shown at the bottom of the income statement, net of tax, as a single amount. This helps investors and analysts understand the company's future earnings potential without the influence of these non-recurring items.

How are extraordinary items reported on the income statement?

Extraordinary items are reported on the income statement as separate line items, net of tax, at the bottom of the statement, below income from continuing operations. These items are both unusual and infrequent, such as a gain from the sale of a discontinued operation or a loss from a natural disaster. By reporting them separately, companies ensure that these non-recurring events do not distort the understanding of their regular business performance. This clear separation helps investors and analysts to better assess the company's ongoing profitability and operational efficiency.

Why is it important to separate discontinued operations and extraordinary items from continuing operations?

Separating discontinued operations and extraordinary items from continuing operations is crucial for providing a clear and accurate picture of a company's ongoing business performance. These items are non-recurring and can significantly distort the financial results if included with regular operations. By reporting them separately, companies ensure that investors and analysts can distinguish between the core, sustainable earnings of the business and the effects of these exceptional events. This separation enhances the transparency and reliability of financial statements, aiding in better decision-making and valuation of the company.

What criteria must be met for an item to be classified as an extraordinary item?

For an item to be classified as an extraordinary item, it must meet two key criteria: it must be unusual in nature and infrequent in occurrence. 'Unusual in nature' means that the event is highly abnormal and unrelated to the typical activities of the business. 'Infrequent in occurrence' means that the event is not expected to happen regularly or repeatedly. Examples include significant losses from natural disasters or gains from the sale of a major business segment. These items are reported separately on the income statement to avoid distorting the company's regular financial performance.

How are discontinued operations presented on the balance sheet?

On the balance sheet, discontinued operations are presented separately from continuing operations. The assets and liabilities related to the discontinued operations are shown distinctly, but they are not netted as a single amount. This separate presentation helps users of the financial statements to clearly identify the resources and obligations associated with the discontinued segment. By doing so, it provides a more transparent view of the company's financial position, allowing investors and analysts to better assess the impact of the discontinued operations on the overall financial health of the company.