Why isn’t the excess of fair value over book value included in Discontinued Operations? I’m currently in Intermediate 1, and this has been a bit confusing for me.
I understand that when assessing Discontinued Operations, impairment costs are included when the book value exceeds the fair value, but I’m curious why it’s not the same when the fair value is greater than the book value.
Any clarification would be greatly appreciated!
One response
In Accounting, discontinued operations refer to components of a business that have been sold or are classified as held for sale, and which represent a strategic shift or significant change in a company’s operations. When assessing discontinued operations, it’s essential to understand how fair value and book value are treated differently, particularly in the context of IFRS and GAAP.
Discontinued Operations Framework: Discontinued operations are reported separately in the financial statements to provide users with a clear view of ongoing operational performance. This means that the financial results of the discontinued operations should reflect their actual performance, which includes losses or gains from the period leading up to their disposal.
Book Value vs. Fair Value: Book value represents the asset’s carrying amount on the balance sheet, while fair value is an estimate of what that asset could be sold for in the current market. When a company’s book value exceeds fair value, it indicates an impairment, which needs to be recognized in the earnings statement to reflect the economic reality of the asset’s current state.
Gains on Disposal: When the fair value exceeds the book value in the context of a discontinued operation, it reflects potential gains from the disposal of that segment. However, these gains are typically only recognized upon the actual sale of the asset. Until the asset is sold, the increase in fair value is not realized, thus it is not included in discontinued operations as it does not affect the income statement directly.
Only Realized Gains Included: For financial reporting purposes, the financial impact of discontinued operations focuses on what has actually been realized, so in the case of fair value exceeding book value, unless the asset has been sold and the gain is realized, it remains an unrealized gain. Impairment losses (when book value exceeds fair value) need to be recognized to provide an accurate representation of the asset’s worth before the disposal.
In summary, the amount by which fair value exceeds book value is not included in discontinued operations because it represents an unrealized gain. Only realized gains and losses related to the disposal of the discontinued operation are reflected in the financial statements. This distinction helps ensure transparency and accuracy in reporting the performance of ongoing versus discontinued operations.