Extraordinary Item: Definition and Explanation

An extraordinary item is a nonrecurring occurrence that must be explained to shareholders in an annual or quarterly report. Examples include the write-off of a division, acquisition of another company, sale of a large amount of real estate, or uncovering employee fraud that negatively affects the company's financial condition.

Extraordinary items are significant, nonrecurring transactions or events that must be distinctly reported to shareholders in a company’s financial statements. These items are separated from regular business activities due to their unusual nature and infrequency to provide clear insights into the company’s operational performance and financial condition.

Definition

An extraordinary item refers to a transaction or event that:

• Is infrequent in occurrence.
• Unusual in nature.
• Has a material impact on the financial statements.
• Requires disclosure in the notes to the financial statements.

Characteristics of Extraordinary Items

• Infrequent Occurrence Extraordinary items rarely happen in the normal course of business. Examples include natural disasters, legal settlements, or significant asset sales.

• Unusual Nature These events or transactions differ from the usual business activities. They are not part of the company’s core business operations and are typically unexpected.

• Material Impact The financial statement must show that the extraordinary item has a significant impact on the company’s financial results, warranting separate disclosure and explanation to stakeholders.

Examples of Extraordinary Items

• Write-off of a Division When a company decides to abandon or write off a significant part of its business, it must report this as an extraordinary item.

• Acquisition of Another Company The significant costs involved in acquiring another company, including the acquisition and integration costs, must be reported separately.

• Sale of a Large Amount of Real Estate A company selling a significant portion of its real estate holdings must report the profit or loss from this sale as an extraordinary item.

• Uncovering Employee Fraud Discovering significant fraud that materially affects the company’s financial statements must be reported separately to inform shareholders about the impact.

Historical Context

Historically, the concept of extraordinary items was introduced to improve financial transparency and comparability across periods. However, the concept has been revised and in some jurisdictions, like under the U.S. Generally Accepted Accounting Principles (GAAP), has since been eliminated to simplify financial reporting and avoid subjectivity in classification.

Financial Reporting and Extraordinary Items

Applicability under IFRS and GAAP

• IFRS: Under the International Financial Reporting Standards (IFRS), the concept of extraordinary items has been removed to ensure all income and expenses are included in the profit or loss from ordinary activities.

• GAAP: Similarly, U.S. GAAP no longer allows for extraordinary item classification. Instead, unusual or infrequent items are disclosed separately within income from continuing operations.

Disclosure Requirements

Companies are required to provide detailed notes in the financial statements about extraordinary items, explaining the nature, financial impact, and any related risks or future considerations.

Comparisons and Related Terms

Nonrecurring Items

Nonrecurring items include abnormal gains or losses that are not expected to recur frequently but are not as unusual as extraordinary items.

Unusual or Infrequent Items

These are transactions that are either unusual in nature or infrequently occurring but don’t meet both criteria required to be extraordinary items under old standards.

FAQs

Are extraordinary items still reported under current accounting standards?

No, extraordinary items are no longer reported under both IFRS and GAAP. However, similar disclosures for unusual or infrequent items are still required within continuing operations.

Why were extraordinary items eliminated from GAAP and IFRS?

They were eliminated to reduce complexity and increase the consistency of financial reporting. This change also aims to avoid subjective judgment in classifying an item as extraordinary.

How should companies report significant nonrecurring items now?

Companies must report significant nonrecurring items in the usual course of financial reporting, often under income from continuing operations, with detailed notes providing clarity to shareholders.

References

1. Financial Accounting Standards Board (FASB). “FASB Accounting Standards Codification.”
2. International Financial Reporting Standards (IFRS).
3. Investopedia. “Extraordinary Items.”

Summary

Extraordinary items are significant, nonrecurring events or transactions that dramatically impact a company’s financial standing. Although no longer classified separately under modern accounting standards like GAAP and IFRS, understanding their history and required disclosures helps in comprehending a company’s financial dynamics and ensuring transparent financial reporting.