Discontinued operations under IFRS - interpretation and management

This thesis investigates the interpretation and management of discontinued operations under IFRS. The empirical work is divided into three parts. The first part examines the interpretation of the term ‘major line of business’. The second part examines whether firms engage in classification shifting by classifying expenses from the continuing part of the income statement to the discontinued part. Finally, the disclosure analysis investigates to what extent firms comply with mandatory disclosures and their main determinants of compliance. Past research on discontinued operations is broadly limited to expert opinions and a few earnings management studies based on US GAAP. This thesis aims to address this gap in knowledge by looking at a European IFRS financial setting. It focuses primarily on the Swiss market, as well as on Germany as a control market and the UK as a comparison market during the observation period from 2009 to 2018. Using different multivariate and logistic regression models throughout the thesis, the data is gathered from publicly available information on a cross-sectional basis and includes more than 8,800 observations in terms of classification shifting and over 600 analysed annual reports for disclosures between 2009 and 2018. The study reveals that firms executing relatively small deals opportunistically use their discretion to apply discontinued operations to benefit from increased core earnings (continuing earnings), which potentially leads to higher equity valuation and impairs the comparability between IFRS adopters. The smallest group applying discontinued operations represents more than 20 per cent of the sample which is questionable in terms of IFRS compliance. Motivated by underperforming discontinued businesses, the study provides evidence that discontinued reporting firms misclassify expenses vertically down from the continuing area to discontinued operations within the income statement. This is particularly prevalent in order to meet or beat analysts’ forecasts, or to comply with lenders’ contracts to avoid violations of debt covenants. In terms of mandatory disclosures, the study provides evidence that firms are reluctant to comply with IFRS mandatory items where items are proprietary, due to the potential for commercial harm. Further, the models reveal that the presence of a Big Four auditor and the size of the company are the main positive driving factors of compliance. The findings of this thesis could have implications for the IASB in view of a future post-implementation review, but also for auditors, lenders and shareholders by alerting them to the potential use of classification shifting as an earnings management technique. Further, the IASB and the audit profession may take note of the conditions under which managers are more likely to initially apply discontinued operations as a result of extensive management discretion. The study also reveals the ineffective role played by non-Big Four auditors in terms of mandatory disclosures which suggests that regulators and the audit profession should step up efforts to enhance their effectiveness in curbing disclosure deficiencies.