How Should the Disposal of a Component of a Business Be Disclosed in the Income Statement?
A company may sell another business it owns to raise funds for an acquisition or to dispose of an asset that no longer strategically fits with its business. When a company sells a business line or component, it books a gain or loss on the disposition. The company records the gain or loss on the disposal on the income statement as an extraordinary item.
Business components are parts of a business that have separate, defined operations. A business component may be a business segment, division or subsidiary. In addition, it could be a department that uses a group of assets but does not yet operate as a wholly separate company. Therefore, your company must treat the disposal of a business component as it would treat the sale of a subsidiary.
When your company disposes of any long-term asset, which are assets owned for at least 12 months, it records a gain or loss on that asset. That gain or loss is outside the realm of ordinary business activities since your company is not in business to buy and sell divisions. Therefore, any gain or loss resulting from the sale of your business component appears as extraordinary income, below operating income on your company's income statement.
You determine the gain or loss of a business component by subtracting its book value and any transaction costs from its sales price. If your company simply shuts down a subsidiary, there is no sales price. In this case, book the disposition as a loss equal to the book value and fees involved in shutting down the business.
Most companies maintain separate financial statements for its subsidiaries, divisions and other business components. When your company sells a division, the net worth of the component shown on its balance sheet is its book value. If your company does not generate a separate balance sheet for the business component, you will need to assign specific assets and liabilities to it. Carve out these numbers from your primary company’s balance sheet to create the division's balance sheet and arrive at a book value.
Your general contracting company has a framing subsidiary. The framing business has no financial statements but all its income, assets and liabilities were tracked with separate codes in your accounting system. Another framing contractor hears you want to leave the framing business and offers $500,000 for it. To calculate the gain, you carve out a separate balance sheet for the framing division which shows a net worth of $300,000. You spend $30,000 on legal and consulting fees arranging the sale. The gain on the disposition is $170,000, which is the $500,000 sales price less book value of $300,000 and $30,000 in fees.