Extraordinary items in accounting are income statement events that are both unusual and infrequent. In other words, these are transactions that are abnormal and don’t relate to the principle business activities. They also are not predictable or occur on regular basis. Historically FASB has required companies to report these transactions separately on the?income statement.
In 2015, however, FASB updated its income statement standard number 2015-01 to remove the separate reporting requirements of these items. Although these requirements will not be in place in the future, I think it’s still important to discuss the old way of treating them verses the new standards.
Originally, FASB required that all business transactions be analyzed for two main criteria: unusualness and infrequency. If a transaction met both of these criteria, meaning it rarely occurred and was outside the scope of normal business operations, management was required to report these events separately in a different section of the income statement. This rule makes sense because creditors and investors want to see if something affecting the income statement had nothing to do with the business operations.
For example, if company reported a huge loss from natural disaster in its income from operations, the net operating income would be artificially low even though its operations might be higher than last year. Thus, reporting it in a separate section of the income statement makes sense. The net operating activities reported are pure, so investors and creditors can see how the core business activities are doing. At the same time, they can see the effects of the extraordinary events on the bottom line.
These events were also required to be disclosed in the company’s financial statement footnotes listing the nature of the events, the extent of the gain or loss, and the income tax ramifications. Management was also required to report and disclose how these items affected the?earnings per share calculation.
Let’s look at a few examples.
Assume Paul’s Orange Grove, located in Florida, is gearing up for a great harvest. Then the weather prematurely gets cold and frosts half of the orchard. Is this considered and extraordinary event? Going by the extraordinary item definition, it must meet both criteria. Is this an unusual event? The answer is no. The weather is part of Paul’s business. Going oranges depends on the environment. Is the loss of crops due to frost infrequent? Again, the answer is no. Although devastating frost doesn’t happen every year, it does happen frequently. Thus, this loss isn’t extraordinary.
If the Paul lost half of his crop to an earthquake, it might be considered both unusual and infrequent because earthquakes don’t happen in Florida. Here’s some examples of what typically was considered extraordinary events:
- Expropriation of property by a foreign government
- Condemning property by a domestic government
- Prohibition of goods or services by a new law
- Losses or gains from an unusual and infrequent act of God?or calamity
As you can see, the problem that FASB found with this concept is that companies rarely have events that meet both of these criteria. Many transactions meet one of the descriptions, but rarely do events meet both. This was causing management and auditors to spend time and resources to investigate every transaction without every finding one that met the required criteria. In other words, it was a waste of time.
Thus, FASB decided to remove the extra assessment requirements, so management, auditors, and prepares don’t have to waste extra time and resources analyzing transactions. Now companies will simply have to decide whether the events were material to their business practices. These material items can be listed separately on the income statement.