The longer you invest, and the more annual reports and Form 10-K filings you read, the more likely you are to come across a company's reported profits organized along two lines: continuing operations and discontinued operations.
The conditions that lead to this distinction can be as varied but usually involve either shutting down a unit that was losing money, selling a subsidiary for one reason or another, or spinning off an operating division.
This is perfectly understandable as times change, businesses adapt, and different lines of business are affected by market forces, regulatory shifts, political environments, technological advancements, and a host of other considerations. It can present a problem, however, for showcasing past financial data to potential investors, whether stockholders or bondholders.
- A discontinued operation might arise because a company has sold a subsidiary, or because it’s shut down an area of operations.
- Discontinued operations are effectively deleted and omitted from the company’s financial data.
- Continuing operations remain up and running and are still accounted for in annual reports and filings.
- Segregating these sets of financial information is required by generally accepted accounting principles (GAAP) rules.
Separating Financial Results
If the financial results of the former business activity that was discontinued are still included in historical financial data as they were originally reported, it would create a large disconnect between where the company was and what its financial results look like now. The solution is to strip the financial results of the discontinuing operations out of the overall financial data as if they were a separate company or had never existed.
The following is a historical example from the dot-com era to demonstrate how continuing operations and discontinued operations might arise on the income statement.
Viacom and Simon & Schuster
In the 1990s, Viacom, owner of MTV, VH1, and Nickelodeon, purchased Paramount Studios. To pay for the acquisition, Viacom took on a large amount of debt. The company's Chairman, Sumner Redstone, began selling assets and businesses the company owned in order to help pay down this debt—even perfectly fine businesses that it had been happy to own in the past.
Simon & Schuster's education division was one of the businesses Viacom decided to let go, ultimately selling it to British media group Pearson PLC for $4.6 billion dollars. The deal affected the company's revenue and earnings in a few different ways.
This is where discontinued and ongoing operations come to the rescue. When Viacom sold Simon & Schuster's education division, it received a large amount of cash from the buyer. However, because it no longer owned the entity, it understandably lost all future rights to any of the ongoing revenue and profits that the publisher generated.
Viacom's management needed a way to warn its investors, "...Simon & Schuster generated [X amount] of our profit and revenue. We no longer own the business, so we will not be earning this same level of revenue and profit next year." To do that, Viacom put a line-item entry on its income statement called "Discontinued Operations." This entry shows investors money that was earned from businesses that won't be part of the company's ongoing operations or holdings for very much longer.
When Companies Use the Discontinued Operations Classification
In most cases, discontinued operations occur because management thinks the new business will perform better than the old business. Segregating the two sets of financial information, which is also required by generally accepted accounting principles (GAAP) rules, allows the company to highlight the ongoing and profitable nature of the surviving entity so that investors can assign a better price-to-earnings ratio to the stock's predicted future performance.
Continuing operations are exactly what they sound like—ongoing concerns, or businesses, that the company expects to be engaged in for the foreseeable future.
Net Income from Continuing Operations
After all of the expenses are deducted, the investor is left with a figure called net income from continuing operations. This is a calculation of the profit generated by continuing operations during the period covered by the income statement.
Net Income from Discontinued Operations
The amount shown on the income statement under discontinued operations is the profit or loss made during the current period from business lines or units that will not be a part of the company in the future.