9.4 IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations

9.4 IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations

Why this belongs in the preparation chapter: IFRS 5 is the standard that decides where things go on the face of the statements. A building being sold moves out of non-current assets into a separate current-asset line. A closing division's entire result is stripped out of every operating line and collapsed into one post-tax figure. Get this wrong in a Section C preparation question and the whole statement of profit or loss is misclassified, even where every individual number is right.

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1. Why a Separate Standard Exists

An asset that is being used and an asset that is being sold are economically different things. The first generates cash through operations over its remaining life; the second will generate a single cash amount, soon, equal to its net selling price. Presenting them identically obscures both.

The same logic applies at business-unit level. If a group closes or sells a major division, the prior year's results include a full year of that division's revenue and costs while the current year includes only part of it. Users trying to forecast future performance need the continuing business separated from the part that is going away. IFRS 5 delivers exactly that separation, and IFRS 18 reinforces it by making discontinued operations one of the five profit or loss categories.

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2. Classification as Held for Sale

An entity classifies a non-current asset (or disposal group — a group of assets and directly associated liabilities to be disposed of together in a single transaction) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use.

Two conditions must both be met:

  CONDITION 1: AVAILABLE FOR IMMEDIATE SALE
  The asset must be available for immediate sale in its PRESENT CONDITION,
  subject only to terms that are usual and customary for sales of such assets.

  CONDITION 2: THE SALE MUST BE HIGHLY PROBABLE
  +---------------------------------------------------------------------+
  | (a) The appropriate level of MANAGEMENT IS COMMITTED to a plan to    |
  |     sell the asset;                                                  |
  | (b) An ACTIVE PROGRAMME to locate a buyer and complete the plan has  |
  |     been initiated;                                                  |
  | (c) The asset is ACTIVELY MARKETED for sale at a price that is       |
  |     REASONABLE in relation to its current fair value;                |
  | (d) The sale is expected to qualify for recognition as a COMPLETED   |
  |     SALE WITHIN ONE YEAR from the date of classification; and        |
  | (e) Actions required to complete the plan indicate that it is        |
  |     UNLIKELY that significant changes will be made to the plan or    |
  |     that the plan will be WITHDRAWN.                                 |
  +---------------------------------------------------------------------+

The traps built into these criteria

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3. Measurement

  STEP 1  Immediately BEFORE classification, measure the asset (or all the
          assets and liabilities in the disposal group) in accordance with
          the applicable IFRS Accounting Standards. A property carried under
          the revaluation model is revalued one final time; depreciation is
          charged up to the date of classification.

  STEP 2  On classification, measure at the LOWER of:
               • CARRYING AMOUNT, and
               • FAIR VALUE LESS COSTS TO SELL
          Any write-down is recognised as an IMPAIRMENT LOSS in profit or loss.

  STEP 3  DEPRECIATION AND AMORTISATION CEASE. The asset is no longer being
          consumed through use; its value will be recovered by sale.

  STEP 4  Subsequently, remeasure at each reporting date to the lower of
          carrying amount and fair value less costs to sell. A subsequent
          GAIN may be recognised, but only up to the CUMULATIVE IMPAIRMENT
          LOSS previously recognised, whether under IFRS 5 or under IAS 36.

Presentation in the statement of financial position: non-current assets classified as held for sale, and the assets of a disposal group, are presented separately from all other assets, normally as a single line within current assets. Liabilities of a disposal group are presented separately from other liabilities. Assets and liabilities of a disposal group must not be offset against each other.

[!WARNING] The depreciation trap is the most frequently examined point in this standard. A machine classified as held for sale on 1 July with a 31 December year end is depreciated for six months, not twelve. Charging a full year is an immediate loss of marks, and it also produces the wrong carrying amount for the Step 2 comparison.

[!TIP] Costs to sell, not costs of disposal. IFRS 5 uses fair value less costs to sell — the incremental costs directly attributable to the disposal, excluding finance costs and income tax expense. IAS 36 uses the near-identical "fair value less costs of disposal" in computing recoverable amount. The two figures will usually be the same number; the difference in wording is not worth losing sleep over, but quoting the right one signals precision.

Assets outside the scope of the measurement rules

Certain assets within a disposal group continue to be measured under their own standards rather than at the lower of carrying amount and fair value less costs to sell — principally deferred tax assets (IAS 12), financial assets (IFRS 9), investment property carried at fair value (IAS 40) and biological assets at fair value less costs to sell (IAS 41). Any residual write-down of the disposal group is then allocated to the assets that are within the measurement scope.

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4. Discontinued Operations

A discontinued operation is a component of an entity — operations and cash flows clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity — that either has been disposed of or is classified as held for sale, and:

  (a) represents a SEPARATE MAJOR LINE OF BUSINESS or a separate major
      GEOGRAPHICAL AREA of operations; OR
  (b) is part of a single co-ordinated PLAN to dispose of a separate major
      line of business or geographical area of operations; OR
  (c) is a SUBSIDIARY ACQUIRED EXCLUSIVELY WITH A VIEW TO RESALE.

The word major does the work. Closing three of forty retail stores is not a discontinued operation; exiting the whole retail channel to become a wholesaler is.

Why identifying discontinued operations matters

The syllabus asks you to discuss the importance of identifying and reporting them, so be ready to write this out:

• Predictive value. Users forecast future performance from the results of the operations that will still exist. Leaving a closing division inside operating profit contaminates the base from which those forecasts are made.
• Comparability across periods. Because the comparative is re-presented, the user can compare like with like: this year's continuing business against last year's continuing business.
• Separating the one-off from the recurring. The gain or loss on disposal is a single, non-recurring event; presenting it inside operating profit would distort the operating margin.
• Faithful representation of management's decisions. The disclosure reveals what management has chosen to exit, which is information about strategy that no ratio can supply.

Presentation

Under IFRS 18, discontinued operations form their own category in the statement of profit or loss, presented as a single amount comprising:

1. The post-tax profit or loss of the discontinued operation for the period; plus
2. The post-tax gain or loss recognised on the measurement to fair value less costs to sell, or on the disposal itself.

An analysis of that single amount into revenue, expenses, pre-tax profit or loss, the related income tax expense, and the gain or loss on remeasurement or disposal is given either on the face of the statement or in the notes. Net cash flows attributable to the operating, investing and financing activities of the discontinued operation are also disclosed.

Comparatives are re-presented so that the prior period's statement of profit or loss shows the same operation as discontinued, even though it was not classified as such at that date. Note the asymmetry that examiners like: the statement of financial position comparative is not restated, because the held-for-sale classification did not exist at the prior reporting date.

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5. Worked Example

Scenario — Denholm Group plc, year ended 31 December 20X6

1. On 1 July 20X6 the board committed to a plan to sell Denholm's entire marine services division, its only operation outside its core industrial business and responsible for 22% of group revenue. Brokers were appointed the same week, the division was marketed at a price close to its independent valuation, and completion was expected in the first quarter of 20X7. The division remained fully operational during the second half of the year.
2. The division's assets at 1 July 20X6, measured under the applicable standards immediately before classification, were: property $4,200,000 (annual depreciation $200,000, charged to 1 July), plant $1,800,000 (annual depreciation $300,000, charged to 1 July), inventories $650,000, trade receivables $410,000. Directly associated liabilities were trade payables of $520,000. Fair value less costs to sell of the disposal group at 1 July 20X6 was $6,000,000 and at 31 December 20X6 was $6,150,000.
3. The division's results for 20X6 were: revenue $9,400,000, expenses $9,050,000, giving a pre-tax profit of $350,000 with a related tax charge of $70,000. The 20X5 comparative showed a pre-tax profit of $480,000 with tax of $96,000.

Step 1: Does the division qualify?

All the held-for-sale criteria are met at 1 July 20X6: management is committed, brokers have been appointed as an active programme, the price is reasonable relative to valuation, completion is expected within one year, and nothing indicates withdrawal. The division is a separate major line of business — it is the group's only marine operation and represents 22% of revenue — so it is also a discontinued operation. The fact that it kept trading is irrelevant; a business is available for sale in its present condition precisely because it is a going operation.

Step 2: Measure the disposal group at 1 July 20X6

Carrying amounts immediately before classification (after depreciating to 1 July):
  Property        $4,200,000
  Plant           $1,800,000
  Inventories       $650,000
  Trade receivables $410,000
  ----------------------------
  Total assets    $7,060,000
  Trade payables   ($520,000)
  ----------------------------
  Net carrying amount of the disposal group   $6,540,000

Fair value less costs to sell                 $6,000,000

Write-down required = $6,540,000 - $6,000,000 =  $540,000

The $540,000 impairment loss is recognised in profit or loss within the discontinued operation. It is allocated first to any goodwill in the disposal group (none here), then pro rata to the non-current assets within the measurement scope — the property and the plant. Inventories and trade receivables are excluded from the allocation because they are measured under IAS 2 and IFRS 9 respectively.

Allocation of the $540,000 write-down across the in-scope non-current assets
(property $4,200,000 + plant $1,800,000 = $6,000,000 of assets within the IFRS 5 measurement scope):
  Property:  $540,000 x ($4,200,000 / $6,000,000) = $378,000  -> carried at $3,822,000
  Plant:     $540,000 x ($1,800,000 / $6,000,000) = $162,000  -> carried at $1,638,000

Step 3: Depreciation after 1 July

None. Depreciation ceases on classification. Denholm charges six months of depreciation to 1 July ($100,000 on the property and $150,000 on the plant, already reflected in the carrying amounts above) and nothing thereafter. A candidate who charges a full year overstates expenses by $250,000 and understates the disposal group by the same amount.

Step 4: Remeasurement at 31 December 20X6

Carrying amount of the disposal group at 31 December 20X6 (no depreciation charged) = $6,000,000
Fair value less costs to sell at 31 December 20X6                                    = $6,150,000
Increase in fair value less costs to sell during the period                          =   $150,000
Cumulative impairment loss previously recognised on the disposal group               =   $540,000
Gain recognised (the increase, capped at the cumulative impairment loss)             =   $150,000
Carrying amount of the disposal group after the write-back                           = $6,150,000

IFRS 5 permits a gain to be recognised for a subsequent increase in fair value less costs to sell, but not in excess of the cumulative impairment loss previously recognised under IFRS 5 or IAS 36. The cumulative impairment here is $540,000, so the whole $150,000 increase can be recognised. The write-back is allocated back to the property and the plant in the same pro rata proportions used for the original write-down.

Step 5: Presentation in the statement of profit or loss

DENHOLM GROUP PLC -- STATEMENT OF PROFIT OR LOSS (extract)
                                                        20X6          20X5
                                                           $             $
  CONTINUING OPERATIONS
  ... revenue and expenses of the industrial business only ...
  Profit for the year from continuing operations             X             X

  DISCONTINUED OPERATIONS
  Profit for the year from discontinued operations    (110,000)      384,000

  PROFIT FOR THE YEAR                                        X             X

Analysis of the discontinued operations figure for 20X6 (note disclosure):
  Revenue                                            9,400,000
  Expenses                                          (9,050,000)
  Pre-tax profit of the operation                      350,000
  Impairment loss on remeasurement to fair value
     less costs to sell                                (540,000)
  Subsequent gain on remeasurement                      150,000
  Pre-tax loss from discontinued operations            (40,000)
  Income tax expense                                   (70,000)
  ---------------------------------------------------------------
  Loss for the year from discontinued operations      (110,000)

20X5 comparative, RE-PRESENTED: $480,000 - $96,000 = $384,000

Step 6: Presentation in the statement of financial position at 31 December 20X6

  CURRENT ASSETS
    ... ordinary current assets of the continuing business ...
    Assets of disposal group classified as held for sale       6,670,000
                                          (= $6,150,000 net + $520,000 payables)

  CURRENT LIABILITIES
    ... ordinary current liabilities ...
    Liabilities of disposal group classified as held for sale    520,000

The assets and the directly associated liabilities are presented separately and without offset. The 20X5 statement of financial position comparative is not restated.

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6. Common Exam Traps

[!WARNING] Trap 1: Continuing to depreciate. Depreciation stops on the date of classification, not at the year end and not on completion of the sale.

[!WARNING] Trap 2: Recognising an unlimited subsequent gain. A gain on subsequent remeasurement is capped at the cumulative impairment previously recognised. An asset cannot be written up above its original carrying amount through IFRS 5.

[!WARNING] Trap 3: Offsetting the disposal group. Assets held for sale and the liabilities of the disposal group are two separate lines, one in current assets and one in current liabilities.

[!WARNING] Trap 4: Treating an abandonment as held for sale. An asset to be scrapped or used to the end of its life is not held for sale, because recovery is through use rather than sale. It can, however, become a discontinued operation at the point it is abandoned.

[!TIP] Re-present the income statement comparative; leave the balance sheet comparative alone. This single sentence answers a recurring two-mark objective test question.