Extraordinary items is a very important term in accounting. It is the events or business transactions, that are unusual in nature and infrequent in occurrence. These items form an integral part of financial reporting since they distinctly mark off normal business operations from rare and unusual occurrences. Correct reporting of extraordinary items leads to greater transparency and accuracy in the assessment of a firm’s financial health.
This article gives in-depth regarding exceptional items, probing the meaning and accounting practice, examples of exceptional items, their place in cash flow statements, and comparing this to extraordinary items, among other subtleties.
What Are Extraordinary Items?
Extraordinary items are events or transactions that are unusual and occur very rarely in the normal course of business operations. Due to their infrequency and unnatural character, such events or transactions must be reported separately so that stakeholders such as investors, creditors, and analysts might fairly determine the operating performance of a company without distortion.
The accounting frameworks like the International Financial Reporting Standards and Generally Accepted Accounting Principles have different guidelines for revealing extraordinary items. However, IFRS eliminated using the term “extraordinary items” in 2015 when they were assimilated into normal income categories, while the GAAP still considers them under strict criteria.
Characteristics of Extraordinary Items
- Unusual Nature: The event is not a typical part of the company’s business activities. Example: A furniture manufacturer losing inventory to an earthquake.
- Infrequency of Occurrence: Such events are not expected to recur regularly within the foreseeable future. Example: Expropriation of assets due to sudden government intervention.
Why Distinction Matters?
Extraordinary items are excluded from operating income to reflect the true performance of regular business activities. They highlight the impact of external factors on the company鈥檚 financial statements, providing a more transparent view to stakeholders.
How Extraordinary Items Are Accounted For
The accounting treatment of extraordinary items follows standard procedures to ensure accuracy and transparency. This involves the identification of the items, quantification of their impact, and reporting them separately.
Steps in Accounting:
- Identification: This can be unusual and infrequent. Example: A natural calamity resulting in heavy loss would qualify as extraordinary.
- Measurement: Measure the impact of this item on the profits, assets, and liabilities of the company. Example: Estimating the cost in terms of damage or loss due to flood.
- Classification: Special items appear apart from regular income on the financial statement, often in conjunction with the determination of net income from normal operations. This is to isolate and analyze the effects of such items as not being part of the normal business performance.
Accounting Standards:
- Under GAAP: Extraordinary items are disclosed separately in the income statement, net of tax effects. Extraordinary items are explained in the notes to financial statements.
- Under IFRS: Extraordinary items are neither treated as a special category but have to be disclosed in a way that stresses their infrequent and unusual nature.
Extraordinary Items Examples
Examples are essential for grasping the application of extraordinary items in real-world scenarios. They vary across industries and are subject to specific circumstances.
Natural Disasters:
- Example: An earthquake destroying a manufacturing plant.
- Impact: Loss of physical assets and subsequent costs for rebuilding, which are outside regular business activities.
Government Expropriation:
- Example: A government seizes land owned by a company for public use.
- Impact: Financial loss due to the sudden and unavoidable relinquishment of property.
Litigation Settlements:
- Example: A one-time settlement of a lawsuit unrelated to regular business operations.
- Impact: Significant financial outflow that is non-recurring.
| Event | Extraordinary? | Reason |
|---|---|---|
| Earthquake loss | Yes | Rare and unusual |
| Inventory obsolescence | No | Regular business risk |
| Legislative asset loss | Yes | Unpredictable and rare |
| Tax revision impact | No | Part of regular business dynamics |
Extraordinary Items in Cash Flow Statements
Extraordinary items also influence cash flow reporting, requiring precise classification to align with their nature. Proper classification ensures that stakeholders can analyze operational cash flows without distortion from extraordinary items, providing a more accurate picture of financial health.
Operating Activities
Extraordinary items affecting cash flows from operations include unusual gains or losses resulting from such events as settlement of legal proceedings, restructuring costs, or write-down of assets. These items are typically included in the operating activities segment of the statement of cash flows, either as additions or deductions from net income to arrive at cash flows from operations. Example: Proceeds received from insurance for an extraordinary loss.
Investing Activities
Other special items related to investment activities, such as gains or losses in the sale of long-term assets, investments, or subsidiaries. Such items generally appear in the investing activities section of the cash flow statement, more so in the cash flows section, to describe investing activities. For example: Proceeds from the sale of land acquired by government mandate.
Financing Activities
Extraordinary items related to financing activities may include gains or losses from debt restructuring, extinguishment of debt, or other significant financing transactions. These items are typically included in the financing activities section of the cash flow statement, specifically in the section detailing cash flows from financing activities. Example: One-time debt settlement.
Difference Between Exceptional and Extraordinary Items
While exceptional and extraordinary items may seem similar, their distinctions are critical in financial reporting.
| Criteria | Exceptional Items | Extraordinary Items |
|---|---|---|
| Definition | Significant but may recur. | Unusual and non-recurring. |
| Examples | Restructuring costs, impairment loss. | Natural disasters, expropriation. |
| Reporting | Part of operating profit. | Separate section below net income. |
| Regulations | Subject to specific guidelines. | Rare and exceptional cases only. |
| Frequency | May occur periodically. | Expected to be one-off. |
| Nature | Within business operations | Beyond regular operations |
| Impact on Income | Included in operational results | Reported separately |
| Disclosure | Highlighted in operational notes | Separate in financial reports |
Extraordinary Items FAQs
Are extraordinary items included in operating income?
No, they are reported separately to avoid skewing the analysis of operational performance.
How do exceptional items differ from extraordinary items?
Exceptional items are significant but may recur, while extraordinary items are both unusual and infrequent.
Are extraordinary items subject to taxation?
Yes, they are reported net of tax, with the tax impact disclosed in accompanying notes.
Can extraordinary items result in positive income?
Yes, such as unexpected gains from insurance proceeds after a disaster.
Are extraordinary items reflected in earnings per share (EPS)?
Yes, but they are disclosed separately to show core EPS unaffected by these items.
