June 1, 2016, to October 31, 2016 ……………………….. $(2,500,000) — November Campbell Corporation management decided discontinue operation its Rocketeer Division and approved
Business & ManagementOperationsWorked Solution
On November 1, 2016, Campbell Corporation management decided to discontinue operation of its Rocketeer Division and approved a formal plan to dispose of the division. Campbell is a successful corporation with earnings of $150 million or more before tax for each of the past five years. The Rocketeer Division, a major part of Campbell’s operations, is being discontinued because it has not contributed to this profitable performance.
The division’s main assets are the land, building, and equipment used to manufacture engine components. The land, building, and equipment had a net book value of $42 million on November 1, 2016.
Campbell’s management has entered into negotiations for a cash sale of the division for $36 million (net of costs to sell). The sale date and final disposal date of the division is expected to be July 1, 2017. Campbell Corporation has a fiscal year ending May 31. The results of operations for the Rocketeer Division for the 2016–17 fiscal year and the estimated results for June 2017 are presented below. The before-tax losses after October 31, 2016, are calculated without depreciation on the building and equipment.
Period_______________________________________Before-Tax Loss
June 1, 2016, to October 31, 2016 ……………………….. $(2,500,000)
November 1, 2016, to May 31, 2017 ……………………… (1,600,000)
June 1 to 30, 2017 (estimated) ………………………………. (300,000)
The Rocketeer Division will be accounted for as a discontinued operation on Campbell’s financial statements for the year ended May 31, 2017. Campbell’s tax rate is 25% on operating income and all gains and losses. Campbell prepares financial statements in accordance with IFRS.
Instructions
(a) Explain how the Rocketeer Division’s assets would be reported on Campbell Corporation’s balance sheet as at May 31, 2017.
(b) Explain how the discontinued operations and pending sale of the Rocketeer Division would be reported on Campbell Corporation’s income statement for the year ended May 31, 2017.
(c) On July 5, 2017, Campbell Corporation disposes of the division’s assets at an adjusted price of $40 million. Explain how the discontinued operations and sale of the Rocketeer Division would be reported on Campbell Corporation’s income statement for the year ended May 31, 2018. Assume the June 2017 operating loss is the same as estimated.
(d) Assume that Campbell Corporation management was debating whether the sale of the Rocketeer Division qualified for discontinued operations accounting treatment under IFRS. List specific factors or arguments that management would use to suggest that the Rocketeer Division should be treated as a discontinued operation. Why might management have a particular preference about which treatment is given? From an external user’s perspective, what relevance does the presentation of the discontinued operation have when interpreting the financial results?
SOLUTION
The Rocketeer Division’s assets should be identified separately on Campbell Corporation’s balance sheet as of May 31, 2017as held for sale current assets and carried at fair value less costs to sell of $36 million.
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The operating loss must be reported as a separate component after income from continuing operations. The operating loss up to year end is presented as a loss from discontinued operations on a net of tax basis. The division assets would be measured at
the lower of carrying value and fair value less costs to sell. The related loss would be presented as a separate component of discontinued operations, on a net of tax basis. Separate earnings per share figures for the discontinued operations are also required under IFRS.
All figures in thousands, except earnings per share:
Income from continuing operations (Note–):
Income from continuing operations (Note–):
$XXX
$XXX
Loss from operation of the Rocketeer
Loss from operation of the Rocketeer
Division less applicable income tax recovery of $1,025
Division less applicable income tax recovery of $1,025
$(3,075)
$(3,075)
Loss on impairment of Rocketeer Division
Loss on impairment of Rocketeer Division
assets less applicable income tax recovery of $1,500*
assets less applicable income tax recovery of $1,500*
(4,500)
$(7,575)
$(7,575)
Net income
$XXX
$XXX
*
Book value of assets
$42,000,000
Fair value less costs to sell
36,000,000
Impairment loss
$(6,000,000
)
Applicable tax (25%)
1,500,000
After-tax loss
$(4,500,000
)
We have presented the calculations in this format in order for the student to better understand how the loss on impairment was calculated. Other formats are acceptable.
The operating loss from June 1- July 5, 2017 is reported as a separate component after income from continuing operations. The operating loss is presented as a loss from discontinued operations on a net of tax basis. The gain on the disposal of the division assets would be presented as a separate component of discontinued operations, on a net of tax basis. The amounts would be disclosed on a comparative basis with the results of the year ended 2017. Separate earnings per share figures for the discontinued operations are also required under IFRS.
All figures in thousands, except earnings per share:
Income from continuing operations (Note–):
Income from continuing operations (Note–):
$XXX
$XXX
Loss from operation of the Rocketeer
Loss from operation of the Rocketeer
Division less applicable income tax recovery of $75
Division less applicable income tax recovery of $75
$(225)
$(225)
Gain from disposal of the Rocketeer Division
Gain from disposal of the Rocketeer Division
assets less applicable income tax of $1,000
assets less applicable income tax of $1,000
3,000
$2,775
$2,775
Net income
$XXX
$XXX
The Rocketeer Division financial results should be shown as a discontinued operation according to the following factors:
Management has “formally” decided to dispose of the Rocketeer Division
The division represents a separate major line of business (as noted – it is a major portion of the company’s operations). It is a separate component of the entity and is operationally distinct, where the operations, cash flows, and financial elements are clearly distinguishable from the rest of the enterprise (as evidenced by the measurement of the division losses) – thus the accountants will be able to measure the loss from operations and disposition of the assets.
There is an active program to find a buyer (negotiations are in process)
Management could argue the following points against using discontinued operations treatment:
Changes to the plan are possible or likely, and
The assets are not available for immediate sale in their current state
Management would usually prefer using the discontinued operations treatment. This separates the financial results of the division from continuing operations and allows users to concentrate on continuing financial results and to assess management performance on the more profitable parts of the business. This also allows users to see the unprofitable impact of the Rocketeer Division on prior years’ results since comparative figures are presented. For a user, showing discontinued operations at the bottom of the income statement after income tax expense and with its own earnings per share information provides more information about the quality and recurrence of earnings.