by John Hughes
Here’s another of the issues arising from extracts of enforcement decisions issued in the past by the European Securities and Markets Authority (ESMA) (for more background see here); this is from their 15th edition:
- “The issuer has oil and gas exploration, development and production operations in various countries. The issuer classified licenses as: producing fields, fields under development, or discovery. In 2011 the issuer sold seven licenses (three producing fields, three fields under development and one discovery licence). The sale of the licences was not a strategic decision to end a specific line of business. All, except one, of the licenses were considered to be separate CGUs.
- The issuer defined each of the producing fields and fields under development as a major line of business, regardless of their size and relative importance. Consequently, all sales of licenses in producing fields and in fields under development were presented as discontinued operations. For licenses in the discovery phase, the issuer defined the major line of business criterion as a fixed CU limit related to the size of the sales consideration. The issuer considered the presentation of the license sales as discontinued operations to provide more relevant and better information to users of financial statements. Accordingly, the issuer presented net income from discontinued operations on a single line in the entity’s Statement of Comprehensive Income.”
The enforcer (as ESMA likes to term it) disagreed with this treatment, concluding that presenting the licence sales as discontinued operations was inappropriate. IFRS 5.32 specifies that a discontinued operation is “an entity’s component that either has been disposed of or is classified as held for sale, and represents a separate major line of business or geographical area of operations, is part of a single coordinated plan to dispose of separate major line of business or a separate major geographical area of operations, or a subsidiary acquired exclusively with a view to resale.” In this case: “the assessment of the issuer was not sufficient to conclude whether or not each sale constituted a component of an entity that represented a separate major line of business. For licenses in the discovery phase, the enforcer’s opinion was that assessment of separate major line is related to the magnitude and relative importance of the business and that a numerical determination alone cannot be considered a sufficient and appropriate operationalization of the guidance in IFRS 5.”
In an ideal world, it would probably be self-evident whether it makes sense to apply the separate discontinued operations presentation to a particular transaction. That is, either it makes sense to set out the company’s recent history in a way that segregates the activities of something that’s being (or already has been) disposed of, or else it doesn’t. If a particular line of business is shifting out of the picture, then clearly its past results aren’t relevant to assessing the entity’s ongoing prospects; investors will be better served with information focusing solely on the operations that remain. Why wouldn’t that apply then to everything that isn’t continuing? Well, applied too liberally, it might only result in losing one’s bearings on an entity’s actual history (as opposed to a theoretical history) – management might endlessly tinker with reported results to get rid of anything they’d rather downplay (the use of adjusted earnings measures sometimes seems to aspire to achieve this by other means).
Somewhere between the obvious major business change that would only lead investors astray if its implications weren’t presented separately, and the everyday ups and downs that should plainly remain a part of the core presentation, there’s one of those famous grey zones, into which standards attempt to bring some clarity. History suggests it’s not necessarily easy to define the line though. Although Canadian GAAP contained a similar notion of discontinued operations, it placed less emphasis than IFRS on whether the component is a separate major line of business or geographical area of operations, and more emphasis on ensuring the entity has no ongoing involvement in the operations it’s discontinuing. And in 2008, the IASB proposed changing the concept, to be “a component of an entity that (a) is an operating segment (as that term is defined in IFRS 8) and either has been disposed of or is classified as held for sale or (b) is a business (as that term is defined in IFRS 3 Business Combinations (as revised in 2008)) that meets the criteria to be classified as held for sale on acquisition.” A subsequent staff draft tweaked the proposed definition again. Although the proposal didn’t go anywhere, the very fact of its existence might be taken as an indication of some inherent elasticity in the concept.
In this case though, the enforcer seems on firm ground, pointing out that selling licenses “appeared to be part of the normal course of business for the issuer that includes continuous change to the composition of the portfolio of licences.” Put another way, if you’re constantly finding operations to discontinue, then that’s probably part of your actual continuing business, and users should evaluate how well you do at it on that basis.
The opinions expressed are solely those of the author