An extraordinary item is non-recurring in nature as it is infrequent and unusual in the normal course of a business’ operations. It cannot be predicted, nor does it occur regularly. A good example is a loss arising from a natural disaster such as an earthquake, flood, contagious and deadly disease, etc.
Before 2015, the accounting board (FASB) required companies to record the extraordinary items separately on the income statement since it was typically a one-time gain or a loss and was not anticipated to occur again in the future.
In 2015, in an attempt to converge to the IFRS standard along with some other reasons (to be discussed later), FASB updated the accounting standard to remove this condition of recording it separately on the income statement.
Financial Statements Template
Throughout this series on financial statements, you can download the Excel template below for free to see how Bob’s Donut Shoppe uses financial statements to evaluate the performance of his business.
Extraordinary Items Before 2015
The original criteria laid out by the Federal Accounting Standard Board (FASB) for analyzing business transactions was two-fold:
If the event did not fulfil the criteria of being unusual and infrequent, the management would continue to report is as income from its ordinary operations.
However, if an event fulfilled the criteria above, the management had to report these extraordinary items separately on the income statement. They were also required to disclose the earnings per share impact of the extraordinary item.
These treatments would assist the investors and creditors to see that this unusual occurrence affecting the profitability of the company has nothing to do with the day to day operations of the business.
The following items, under US GAAP, cannot be treated as an extraordinary item:
- Sale of an asset
- Lease of equipment to someone
- Intangible assets
- Foreign currency translation
- Property abandonment
- Loss due to strikes
- Accruals on some long-term contract
Extraordinary Items After 2015
In 2015, the FASB made changes in the accounting standard, US GAAP, to eliminate the requirement of reporting the extraordinary items separately in the income statement. The companies and auditors do not have to identify whether a certain event or transaction is an extraordinary item. However, they do still have to report it on the income statement and follow the disclosure guidelines from before.
The reasons for this change were:
- The older treatment was more costly and complex to implement.
- Regulators and auditor spent way too much time in determining whether an event falls under the criteria or not.
- The threshold of an event being characterized as an ‘extraordinary item’ was so high that very few businesses ever got to report them. At the time when FASB was discussing to do away with this requirement, only 30 companies had reported an extraordinary item in the past five years.
Hence, it should be clear that the companies are still required to report all such transactions, that would have previously come under ‘extraordinary items’, on their income statements. The only difference being that they do not have to explain the event or calculate the earnings per share (EPS) impact of it. For example, an extraordinary item can now directly be reported as ‘loss due to foods’ on the profit and loss statement.
The above treatment relates to accounting of extraordinary items under US GAAP. In International Financial Reporting Standards (IFRS), the concept of extraordinary item does not exist at all.
Types of Extraordinary Items
The extraordinary items used to be subdivided into two categories:
- Extraordinary gains
- Extraordinary losses
These will have a positive effect on the net income or ‘bottom line’ of a company. Examples include:
- Gain from disposing or selling of discontinued business segments.
- Govt related announcement related to subsidies to be sanctioned immediately.
These will have a negative effect on the net income or ‘bottom line’ of a company. Examples include:
- Loss due to calamities such as floods, earthquakes, deadly disease etc.
- Loss from disposing or selling of discontinued business segments.
- Penalties imposed due to loss in a legal case.
The above list is not exhaustive at all and can also vary in nature from business to business:
- For example, a business which is operating in a flood prone area cannot report losses due to a flood. This is because it is an inherent and an existing operational risk which the company is aware of and measure should have been taken to mitigate it.
- Another example is that of a venture capital firm or a private equity firm that sales one its business for huge gains. This cannot be treated as an extraordinary item for a private equity firm since it relates to the core operations of that company.
Extraordinary Items Example
Although in our ongoing case study related to Bob’s donut shop, we have not yet faced a situation where an extraordinary or a non-recurring item has occurred, the following are some hypothetical events that would fall into the extraordinary category:
- A customer slips on a slippery floor in Bob’s shop and sues the company. Bob will have to treat this as an extraordinary loss if he loses the legal case and penalties have ensued.
- Another situation could exist where a high-speed heavy load vehicle crashes into his store causing major repairs and damages which are not fully insured. The resulting losses will be treated as an extraordinary item.
- An earthquake hits the city and Bob’s premises and fixtures are severely damaged during this event. The resulting losses will be treated as an extraordinary item.
The following events that will not fall in the extraordinary category are:
- If Bob’s kitchen accidentally catches fire and cause physical damage to the shop. This will not be considered as ‘extraordinary’ since it is an inherent and existing operational risk which Bob should have been aware of and should have taken measures to mitigate it.
- If Bob’s shop gets temporarily closed by the food authority for not meeting the health standards. The resulting losses will not be deemed extraordinary since it falls in the operational risk category.