Extraordinary Item: Definition, Mechanism, and Historical Requirements

An in-depth examination of extraordinary items, their historical usage in financial reporting, and the implications of their removal from GAAP standards in 2015.

Extraordinary items were gains or losses arising from unusual and infrequent events, previously delineated separately on a company’s income statement. These items provided stakeholders insight into non-recurring events impacting financial performance.

Historical Context and Removal from GAAP Standards

Introduction to Extraordinary Items

Extraordinary items gained recognition under Generally Accepted Accounting Principles (GAAP). These items were distinguished from regular business operations to ensure transparent financial reporting.

Removal from GAAP in 2015

In 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-01, effectively eliminating the concept of extraordinary items from GAAP. This change aimed to simplify income statement presentation and reduce subjectivity in categorizing transactions.

Mechanism of Extraordinary Items

Criteria for Classification

For an event to be classified as an extraordinary item, it needed to meet two primary criteria as per the old GAAP guidelines:

• Unusual Nature: The event must be highly abnormal, unrelated to, or only tangentially related to, the company’s normal business operations.
• Infrequency of Occurrence: The event must not be reasonably expected to recur in the foreseeable future.

Reporting and Disclosure

When an event met these criteria, companies were required to report extraordinary items net of applicable taxes, separately from other forms of income and expenses on the income statement.

$$ \text{Net Income} = \text{Normal Income} \pm \text{Extraordinary Items} $$

Applicability and Examples

Applicability

Extraordinary items were applicable across all industries. Examples included natural disasters, expropriations, or accounting changes from irregular tax laws.

Example Cases

• Natural Disaster: Gains/losses from uninsured property destruction due to a once-in-a-lifetime flood.
• Government Expropriation: Uncompensated long-term asset seizure by government entities.
• Legal Settlements: Settlements from one-time, uncontrollable legal disputes.

Related Terms and Comparisons

Unusual Gains and Losses

Unlike extraordinary items, unusual gains and losses do not meet both criteria for classification but still present significant impacts on financial statements.

Discontinued Operations

Discontinued operations involve parts of a business that have been sold or disposed of, reported separately for clearer performance insights.

FAQs

Why were extraordinary items eliminated from GAAP?

The elimination aimed to streamline reporting processes and reduce the subjective nature of classifying events as extraordinary, thereby enhancing comparability and consistency across financial statements.

How do companies handle events previously classified as extraordinary under current GAAP?

Currently, such events are included in operating results, providing context through footnotes rather than separate disclosure.

References

• Financial Accounting Standards Board (FASB). “Accounting Standards Update No. 2015-01”.
• Generally Accepted Accounting Principles (GAAP).
• Historical financial statements of various corporations pre- and post-2015.

Summary

The concept of extraordinary items once provided a lens into unique financial impacts on business operations. However, changes in GAAP aimed at simplifying reporting and improving comparability have led to their removal, folding such events into general operational metrics with appropriate context provided in financial statement footnotes.