Question

On November 1, Y1, a company adopted a plan to dispose of a component of the business. The component qualifies for

discontinued operations treatment. During Y1, the component had pretax operating losses of $120,000. The component’s

assets have a book value of $800,000 on December 31, Y1. A recent market value analysis of these assets placed their

estimated selling price at $500,000, less a 5% brokerage commission. Management appropriately determines that these assets

are impaired and expects to find a buyer for the component and complete the sale early in Y2. Use a 20% income tax rate and

determine the gain or loss from discontinued operations under either of the following two assumptions

A. A recent market value analysis of these assets placed the estimated selling price at $500,000.

B. A recent market value analysis of these assets placed the estimated selling price at $1,000,00

Answer 1

In case of component classified as discontinued operations as per US Generally Accepted Accounting Principles companies are not allowed to include expected gains or loss from operations in future periods till they occur.

Exception : expected loss from impairment testing. GAIN MUST NOT BE REPORTED until occurs.

PRETAX OPERATING LOSS $ 120,000 will be included in income statement in both cases.

Case 1.

Book value of assets $800,000.

NRV ( Net realisable value) = Fair Market value - disposal costs

$ 500,000 - 5% brokerage comission of $500,000 (market value )

$500,000 -$25,000

$475,000

Impairment loss = book value - NRV

$800,000 - $475,000

$325,000.

In case of discounted operation there will be single after tax amount of gain or loss to be shown after income from continuing operations.

Single amount of loss = $120,000 + $325,000 =$445,000

After tax amount of loss to be shown in income statement = 445,000 - 20% of 445,000 tax amount

= 445,000 - 89,000

=356,000

Case 2

Book value of assets = 800,000

NRV = Fair market value - brokerage comission

$1,000,00 -5% of $1,000,00

$95,000.

Impairment loss = BOOK VALUE - NRV

=$800,000 - $95,000

=$705,000.

As mention in case 1 there will single after tax amount for discontinued operations after income from continuing operations in income statement.

Loss from discontinued operations = $120,000 + $705,000

=$825,000 subject to 20% tax

=$825,000 - $165,000

=$660,000.