Here’s another issue considered a while ago by CPA Canada’s IFRS Discussion Group:
- “A reporting entity’s (the “Parent Entity”) operations consist of the exploration for and evaluation of mineral property interests. The Parent Entity’s mineral property portfolio consists of interests located in two countries – Country A and Country B. The mineral properties are held by a subsidiary in each of the two countries – Subsidiary A and Subsidiary B. Each subsidiary has a local manager and staff that are responsible for executing the work plan prepared by the senior management of the Parent Entity. In addition, the staff works with local officials to ensure compliance with applicable laws and regulations and ensure the rights to the mineral properties are maintained. The subsidiaries do not act autonomously and the senior management of the Parent Entity makes all investing and financing decisions. All financing is arranged by the Parent Entity and advanced to the subsidiaries by way of intercompany loans.
- During the reporting period, the Parent Entity’s senior management decided to focus its exploration and evaluation work on the mineral properties located in Country A. The decision was due to the fact that the mineral properties in Country A showed more promising results and were attracting more interest from investors. Subsidiary B was therefore sold to a third party resulting in a loss on disposal. As a result of the disposal, the group has no further activity in Country B.”
The group considered whether subsidiary B should be presented as a discontinued operation in these circumstances. IFRS 5 says this presentation applies to a “component” of an entity that either has been disposed of or is classified as held for sale and that (usually) represents a separate major line of business or geographical area of operations; it says a component of an entity will have been a cash-generating unit or a group of cash-generating units while being held for use. In the situation above, subsidiary B might sound like a separate geographical area of operations. But on the other hand, given the financing structure and the absence of revenue, it may not constitute a cash-generating unit.
It doesn’t appear that group members had a completely unified view on the matter. The predominant view seems to be this: “A few Group members noted that if the subsidiaries were separate operating segments, presenting the disposal of Subsidiary B as a discontinued operation would be appropriate. However, if the subsidiaries were not separate operating segments, then it would not be appropriate to present the disposal of Subsidiary B as a discontinued operation.” Although that might seem likely to be broadly reasonable in many cases, it shouldn’t suggest a necessary alignment between the concepts of IFRS 5 and those of IFRS 8. For example, situations might arise where a particular business unit has never been reported as a segment (because, say, the chief operating decision maker has never had a practice of separately reviewing its results) but can be identified on its own terms as being a separate geographical area of operations.
Among other observations: “Group members indicated that if there is only one cash-generating unit, it would be difficult to support presentation as a discontinued operation.” This recalls something that was more specific in old Canadian GAAP: “discontinued operations accounting should not be adopted when the enterprise has no substantial continuing operations. The objective of presenting discontinued operations as a separate item of income or loss is to segregate the results that have been discontinued from the results of continuing operations. When there are no significant continuing operations, such segregation is not appropriate.” Where though there are two cash-generating units, and one of them is being discontinued, then there seems to some value to making sure investors can follow how much of the previously reported historical activity relates to one versus the other. But it shouldn’t be too difficult for preparers to get that information across, regardless of whether or not an issuer applies the formal mechanics of discontinued operations presentation.
As a final observation, I said above that subsidiary B might sound like a separate geographical area of operations, but that could depend on what you consider to be “operations”:
- One Group member observed that IFRS 5 includes the notion of an operation that is not necessarily a business. In this fact pattern, there appears to be some form of operation (for example, employees conducting activities) even though the entity is in the exploration and evaluation phase. As a result, there may be room for judgment to be applied to describe what that operation is in the context of this fact pattern. However, another Group member thought that an operation implied more than carrying out an exploration program, but having revenue and outputs as well.
If the latter view is correct, then it might suggest that such a business unit wouldn’t be reported as an “operating segment” either – how can something be an “operating segment” if it’s not regarded as having “an operation”? But on the other hand, could it possibly hurt to do so? Perhaps this whole issue really only reflects how IFRS is predominantly directed at large, established companies: for those entities, there’s greater potential for financial statements to mislead investors by, say, blurring the distinction between continuing and discontinuing operations. But when there’s little going on, and it’s essentially easy to convey which numbers belong where, focusing on the technicalities might only cause the analysis to collapse in on itself. Faster than an abandoned mine!
The opinions expressed are solely those of the author