In an effort to update the financial reporting process, the Financial Accounting Standards Board (FASB) has altered its guidance on reporting discontinued operations at the start of 2015.
Under the new guidance, “unnecessary complexity” is peeled back, according to FASB board member Thomas Linsmeier.
“Many investors felt that under existing GAAP, too many disposals of assets qualified for discontinued operations presentation,” he said in an informational video. “According to the old guidance, a discontinued operation could include a reportable segment, an operating segment, a reporting unit, subsidiary or even an asset group. Under this catchall definition, routine disposals of small groups of assets were often reported as discontinued operations [which] wasn't helpful to investors.”
The new guidance, Linsmeier said, changes the current definition of discontinued operations so that only disposals of components of an organization that represent major strategic shifts qualified for discontinued operations in financial reporting.
PwC Energy partner Doug Parker explained in an interview with sister title Infrastructure Investor that one of the most challenging areas of the prior guidance, determining whether cash flows were eliminated as a result of the disposal, was removed under the new rule. Illustrating his point via a hypothetical scenario, he noted that those calculations could quickly become extremely complex.
“If you imagine a company that owns two gas stations right across the street from each other but then sells one of those gas stations who plans to level the station and put in a restaurant instead, the question under the prior guidance was whether those customers that otherwise would've stopped at the pulled station will begin going to the remaining station, or in other words really shift their business, to that station or go to a competitor maybe further down the road. The concept is known as customer migration, and it really triggered a whole series of questions that were quite difficult for companies to answer,” he said.
“For example, did the company that owned gas stations have strong brand loyalty, and if so, how many customers do they expect to patronize the remaining store? Customers may have been members of that brand's reward program, or maybe they simply liked the coffee. On the other hand, maybe the stations were located at a very busy intersection, such that it wasn't convenient for traffic moving in one direction to pull across to the station across the street,” he added.
Parker reckoned the new guidance better aligns with how management companies and investors view their businesses from a strategic perspective.
“I characterize it as a clearer financial picture. So when a company now reports discontinued operations, that discontinued operations really does signal a major change in the business, and to use the terminology in the standard, a 'strategic shift', that's expected to have a major effect,” he said.
While the FASB intentionally chose not to set bright lines in the guidance, two examples of what might represent a strategic shift are included: the sale of a product line that represents 15 percent of total revenues, and an offloading of assets across a geographic area representing 20 percent of a company's presence.
Beyond simplified reporting, a side benefit of the new guidance is that it brings US GAAP reporting standards closer in line with International Financial Reporting Standards (IFRS), a long-time goal of the FASB.
“The original goal was to converge US GAAP with IFRS in its entirety. This standard brings us much closer,” Linsmeier said. “Part of our new definition for discontinued operation was based on IFRS guidance that a discontinued operation should represent a separate major line of business or geographical area of operations. In the new standard those items are included as examples of disposals that result in a strategic shift that has a major effect on an organizations operations and financial results.”