 Hello, and welcome to this session in which we would look at this continued operation. This is part of the income statement series. This topic is covered in intermediate accounting, either chapter three or four. And obviously, this topic is covered heavily on the CPA exam, the FAR section. Whether you are an accounting students or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. I'm a useful addition. I am a supplemental material to your CPA review course. I provide you alternative resources, multiple choice resources, lectures that's aligned with your CPA review course. I have resources for other accounting courses. And my material are aligned with your CPA review course. So it's very easy to go back and forth between my material and your CPA review course. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other, connect with me on Instagram, Facebook, Twitter and Reddit. So let's take a look at what is the big idea of this continued operation. Think of a company like GE, General Electric. What do you think of when you think of GE? Well, most likely when you say GE, I think about a refrigerator, your home refrigerator. But GE does more than just home refrigeration. They have an aviation segment, a capital segment, a healthcare segment, renewable energy segment, power segment and many other segment. Let's assume GE wanted to sell their aviation segment. What's going to happen? If that's the case, then they have to report this information separately. So why do they have to report this information separately? Well, think about it. Once GE get rid of that aviation segment, any gains or any losses, any contribution or any losses was generated from that division will not reoccur. So you want to tell the investors, look, just for future years, don't take into account the aviation segment. If we're generating income from it, take it out of your analysis. If we're generating losses, take the losses out. So simply put, we're going to give more information to users, investors and creditors to assess the amount, timing and uncertainty of cash flow. And that's the whole purpose of the income statement is to give information. When you get rid of a division, if it's relevant, then you will let investors and creditors know about it. When does a discontinued operation happen? Well, it's when we eliminate a component of a business. What is a component of a business? A component of a business is a division where we can keep track of its cash flow and operation separately for financial reporting purposes. It's distinguishable, identifiable for financial reporting purposes and it's large enough. It represents a strategic shift. Now, what is a strategic shift? Well, the product line that we are getting rid of, if we're getting rid of a product line, is 15% of our total revenue. And that's a substantial amount. You're getting rid of 15% of your revenue. Let us know about this. Or the sale of a geographical area represent 20% of the company total asset. You're selling, for example, your European division and that's 20% of your assets. That's pretty serious. Let us know about this. If you're selling an equity investment, a stock investment in another company and that equity investment represent 20% of your company's asset, your company's asset, not the investment asset, your company's asset, then you have to let us know about what's going on. Now, selling a part of the business is not a discontinued operation. On the exam, they always try to trick you. Selling a part of the business is not a discontinued operation. And I'm going to talk about this a lot. Amounts are reported net of tax. What does it mean net of tax? We'll get to it. Just know it's net of tax. Have it in your mind. This continued operation is reported net of tax. Don't worry. I will show you what does it mean shortly. Let's take a look at an example to see how this all fits together. Adam Inc, a highly diversified company, decided to, decides to discontinue its healthcare segment. During the current year, the healthcare segment lost 3,500 net of tax. Adam sold the division at the end of the year at a loss of 2,000 net of tax. Please ignore net of tax for now. I'll explain what does that mean shortly. So how do we report this information? Because this sale of the healthcare division is considered a strategic shift. So what we do is Adam is going to compute his revenues minus expenses to get to income from continuing operation. Then right underneath this income from continuing operation, we would list loss from the operation of this continued healthcare segment, 3,500 from operating the business, and we sold the business and we had a loss of 2,000. So together, they amounted to a loss of 5,500. Now we have income from continuing operation minus the loss gives us income of 25,357. So let's take this picture here and let's make it fit in the whole overall income statement. So this is the income statement, the actually that we prepared in the prior session. We had, this is a multiple step, we had sales minus cost of goods sold will give us gross profit. So this is one section. Then we have operating expenses broken down by two sections, selling expenses and administrative expenses, total operating expenses 26,000 gross profit minus operating expenses will give us income from operation. I told you this is an important number because this section here represent the operating section of a business. What does that mean? It means this is what they do for a living every day and it seems they're making a profit. Then we're going to have the non operating section that's including other revenues and gains, other expenses and losses. So this is the other section, the big, the second section, the major section operating, non operating and the third section was the tax and we did prepare this income statement in the tales in the prior session. But notice what happened here. Now we have, this was the old net income 30,857. Now this line here is called income from continuing operation. Why? Because we're adding the scenario that Adam is selling, getting root of what? Getting root of its healthcare segment. Therefore we would report the healthcare segment at the bottom as discontinued operation. We're telling investors, look, look right here, pay attention. This healthcare segment, this healthcare division is no longer part of our business. So when you make your, when you run your numbers for next year, don't take it into account. We incur losses. Don't take it into account. We're no longer going to incur losses or if we're generating gains or income, we're no longer going to do that. So that's why we listed separately. Also what we have to do is we have to report earnings per share from continuing operation and earnings per share for discontinued operation, for these two numbers. Well, we'll talk about earnings per share in the next session. I'm going to keep that for the next session. But here's what I want you to notice and hopefully you notice this that we have taxes in two different places. We have taxes here and we have taxes here. In other words, we are allocating the taxes in two different places. Some tax was allocated to the income from continuing operation and other taxes was allocated to the continuing, to the discontinued operation. This is called the intra period tax allocation, allocation of a tax within a period on the income statement. Why do we do that is to help users to assess, to understand the impact of income taxes on various components. So we want to show you here's how much we're getting hit with taxes on our continuing operation and here's how much we are savings or incurring in taxes on our losses from discontinued operation. So the tax will be applied to income from continuing operation, which is the $8,203 that's part of it. And we have taxes that is reported separately and we're going to see how from the discontinued operation. Again, why do we do that? Because tax is a real cost. Tax is a large cost for many businesses. Tax is your largest cost. Believe it or not, tax is your largest expense, although people don't think about it, but it is for a lot of businesses. So it helps us predict the amount, timing, and uncertainty of taxes and taxes is important. It's a real cost. So let's take a look now at an actual example to illustrate the concept of net of tax because I kept saying from the beginning, you know, discontinued operations are reported net of tax. What does that mean? Well, let's take a look at an example here and we're going to be starting with the gain scenario because it's easier to understand a gain scenario. Adam has income before income tax of $200,000. It has a gain of $40,000 from discontinued operation and $6,000 for operating the business. So they sold, this is the sale, and this is the loss from operating the business, assuming 21%. How would Adam present the information? Well, first Adam had 200,000 income before income taxes. We multiply this amount by 21%. We'll have to pay $42,000 on that amount. Then we have a line called income from continuing operation. Now, if we have any discontinued operation, the discontinued operation is listed separately and we do. We sold the division and we have a gain of $40,000. Well, guess what? That's good news. We have a gain. The bad news is Uncle Sam is going to take part of it. The part is 21%. Then we're going to have to pay Uncle Sam $8,400. Therefore, the gain, we report the gain net of tax. Net of tax is $31,600. We operated the business. We generated a gain of $6,000. That's the good news. The bad news is Uncle Sam will take a part of it. $1,260. $47,000. $70,000 is net of tax. And this is what we meant by gains and losses are reported net of tax. Simply put, we want to show the tax effect separately, separately. Then we can compute net income, which is taking income from continuing operation plus the gain plus the gain to come up to net income. So the gain is easy to understand. How about if we change the scenario and same exact numbers except selling the division, we incurred the loss. In operating the business, we incurred the loss. Now, sometimes you could have sell it at a loss operating the division of a gain, but I'm keeping the losses together and the gains together just for the sake of illustration. So let's again start again. Income from continuing operation is $200,000. We have income tax of $42,000. So income from continuing operation is $158,000. Now, since we have a loss, that's bad news. Let me explain something to you. Let's assume you have several businesses and one of them incurred a loss. So let's assume you're running a business. You had revenues of $80,000, expenses of $180,000. Keep the numbers simple. And you have a loss on that business of $100,000. That's the bad news. The good news is this. This loss is deductible. Deductible means you can deduct this loss on your taxes. Well, if you are in a 21% tax bracket or your corporate tax rate is 21%, simply put, you have savings of $21,000. Why savings? Once again, your loss is $100,000. That's bad news. However, because you had that loss, you were able to deduct this as an expense. If you were able to deduct it as an expense, it reduced your taxable income by $100,000. And by reducing your taxable income by $100,000, you reduced your taxes by $21,000. Therefore, I would say my loss is $100,000. I had savings of $21,000 on my taxes. So net of tax losses, net of tax savings, net of tax, my loss is only $79,000. So notice I started with a loss of $100,000. That's really bad. But I was able to deduct, to subtract, to reduce my taxable income on my taxes by $100,000. As a result, I saved $21,000. Otherwise, if I could not deduct this, my taxes would be $21,000 higher. Since I was able to deduct this, my losses are lower because I saved. Therefore, how does it apply for this continued operation? Let's go back here. We had a loss of $40,000. That's bad news. However, since that loss is deductible, well, if we take $40,000 times 21%, that loss gave us savings, savings of $8,400. How so? Again, when you have this deduction on your income, on your income tax, it's going to give you a savings. Therefore, your net loss, this is loss, net of tax. It's still a loss. But the loss went down to $31,600 because you were able to use some of that deduction as tax savings. Same thing with the $6,000. The bad news is $6,000. When we multiply it by 21%, we have savings of $1,260. Notice it's $6,000. But net of tax, the loss is $4,740. So it's still a loss, but the loss is lower because we were able to save. So the tax savings are the $8,400, the $1,240. And this is an important concept, net of tax. Because you're going to see this when you do capital budgeting because depreciation is a tax shield. So depreciation, something that's going to give you tax savings. So understanding what net of tax is is extremely, extremely important. Now your net income, you went from $158,000 minus the $31,600, minus the $4,740. Your net income is $1,260,000. So make sure you understand what net of tax is. Let's think about it. Again, if you made $1,000 in profit, not in profit, if you earn $1,000 from your business as an employee, not from your business as an employee, your take home amount maybe could be only $800 if you pay 20% in taxes. So this is the amount, net of tax. This is if you have an income, not a loss. But the point is what you take home, net of tax, not the gross amount because you have to pay taxes. At the end of this recording, discontinued operation is an important concept. If you like this recording, please take a look at my website. Again, I don't replace your CPA review course. I'm a useful addition to your CPA review course. I can help you understand the material better. My course catalog include many courses. And don't hesitate, invest in yourself, study hard, good luck, and of course, stay safe.