Extraordinary Item

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What Is an Extraordinary Item?

An Extraordinary Item is a transaction or event deemed extraordinary in accounting that is unrelated to routine business operations and unlikely to happen again soon.

According to Generally Accepted Accounting Principles (GAAP), extraordinary items are no longer used formally. Hence the information that follows is historical. In addition, the notion of an unusual item is absent from International Financial Reporting Standards (IFRS).

Additionally, they are unpredictable and do not frequently occur. Therefore, in the past, FASB has mandated that businesses record these transactions separately on the income statement.

However, the FASB changed its income statement standard 2015-01 in 2015 to eliminate the need to report these items separately.

Even though these requirements won't exist in the future, I believe it's still crucial to compare the previous standards and how they address them.

All company transactions were initially required to be examined for two key factors by FASB: unusualness and infrequency.

Management was required to disclose these events separately in a different area of the income statement if a transaction met both of these requirements, i.e., it happened seldom and was outside the normal course of business operations.

This rule makes sense since creditors and investors want to know whether an event that affects the income statement is unrelated to the company's operations.

Two remarkable examples are the devastation of buildings by an earthquake or the ruin of a vineyard by a hailstorm in an area with extremely infrequent hail.

Crop damage caused by weather in a place where it was rather common illustrates an event that did not qualify as unusual.

Companies sought to designate as many losses as unusual items as possible to move them to the bottom of the income statement for reporting purposes, which necessitated this level of precision.

Unusual items were reported in distinct line items on the income statement to make it clear to the reader that they were completely unconnected to a business's operational and financial performance.

Key Takeaways

An extraordinary item refers to gains or losses from events that are unusual in nature and infrequent in occurrence. Due to their rare and exceptional nature, these items are distinguished from normal operating results.
The separate disclosure of extraordinary items, when it was required, helped analysts and investors assess the core operational performance of a business by isolating the effects of unusual and infrequent events.
Extraordinary items were reported net of tax, meaning their tax effects were directly reflected in the financial statements. Understanding the tax implications of these items was crucial for accurate economic analysis and reporting.
Current standards (such as FASB ASU 2015-01) have eliminated the concept of extraordinary items, requiring that such events be reported within continuing operations.

Features of an Extraordinary Item

Gains and losses from special business transactions that stand out from the norm as extraordinary items are referred to as such. They, therefore, relate to transactions that are not a standard component of the company's daily activities.

Among the crucial elements are the following.

Rare/Unusual

They are deals that don't happen every day. It may only occur once every five or ten years, occasionally, or never again for the rest of the company's existence.

It is important to remember that not all unique, unusual, or non-recurring transactions fall within the category of extraordinary items. Likewise, non-recurring transactions are possible but not necessarily extraordinary.

Example 1: PQR Co. believes there is a lot of room for revenue growth in the industry despite the constrained current manufacturing capacity for buses.

Management has authorized purchasing a new plant to boost production capacity in light of this. Therefore, despite the fact that it is a one-time transaction, it might be considered a boost to capital assets rather than a substantial loss.

Example 2: Using PQR Co. from the first example, they aim to stop manufacturing cars, which is a non-recurring transaction and, hence, qualifies as an unusual gain.

Materiality

The primary highlighted characteristic of extraordinary items is the exceptional and occasional occurrence of the transaction. These transactions are unexpected and not common.

These are distinct acts taken for the smooth operation of the firm daily, independent from the regular daily business transactions.

Materiality refers to whether or not an item is truly impactful for the business.

Example 1: If ABC Co. disposes of a business car in Chicago for scrap, the resulting business gain of $20,000 will not be significant enough to be categorized as an unusual gain.

This is because $20,000 is immaterial, given that XYZ Co.'s total revenue is $ 200 billion.

Example 2: A small-time vendor who sells hotdogs outside Northern Park earns a royalty of $500 for selling his hotdog recipe to a chain restaurant.

Because this transaction exceeds the materiality criterion, it is classified as an extraordinary item. It matters in this instance because the shop has an annual profit of roughly $5000.

Purpose of Extraordinary Items

Rare but noteworthy events are handled as extraordinary items to prevent them from distorting a company's normal profitability. Financial analysts frequently leave out extraordinary items when determining a company's P/E ratio to understand its profitability better.

Companies publish unusual items individually in their financial statements to provide investors with a more accurate picture of their continuing costs and income.

The classification of a big loss as an unusual item may help a company paint a more accurate picture of its financial performance.

GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) outline how unusual items in a company's books are treated to preserve uniform accounting standards across businesses.

If an event or transaction was unique and rare, it was considered extraordinary. An uncommon incident must be extremely unusual, unconnected to a company's routine operating activities, and reasonably anticipated not to happen again.

For some companies, this line item was frequently not presented for years. As a result, companies had to estimate the income taxes resulting from extraordinary events and declare the impact on earnings-per-share (EPS) in addition to segregating the impact of these items on the income statement.

Losses from different catastrophes, such as earthquakes, tsunamis, and wildfires, are examples of extraordinary items.

Identifying and calculating the impact of some extreme events (such as fires) was simple. Still, it was far more challenging to calculate the impact of other events that indirectly impacted business operations or the economy as a whole.

Types of Extraordinary Items

A distinction between extraordinary gains and losses can be made. In contrast to remarkable gains, which positively affect the company's profit, losses hurt the company's profit.

Examples of Extraordinary gains

Profit from the government's new statement that subsidies will be approved.
Gain from the sale of company segments that have been discontinued

Examples of Extraordinary Losses

Loss from the sale of discontinued business parts; Loss resulting from uncontrollable natural disasters such as earthquakes, floods, hailstorms, etc.
Loss as a result of a court decision creates severe tax consequences
The loss resulted from a protracted workers' strike that has negatively impacted operations for more than a month.

The aforementioned examples are illustrative and subject to change depending on the circumstances of each situation.

For instance, firms in areas designated as flood-prone areas cannot claim a loss caused by a flood as an extraordinary loss.

This is because it is assumed that firms are aware of the local climate and are, nonetheless, ready to accept the risk of operating there. This is, therefore, a component of the business risk that the firm must have already considered.

We may also use the example of a private equity company that specializes in investing in start-ups.

In this instance, a gain or loss from selling a firm is common and neither uncommon nor abnormal. Because of this, it cannot be claimed that the profit from selling long-term investments was significant.