Extraordinary items in accounting
May 23, 2014
Estimates and uncertainty are both normal for companies, but sometimes an event occurs that might be considered unpredictable even by corporate standards. Should these improbable events be mixed in with the results of regular operations or should they be reported separately? U.S. GAAP and international accounting standards (IFRS) disagree on the answer to that question.
U.S. GAAP defines an extraordinary financial item as both unusual and infrequent. In laymenís terms, itís something that happens outside the normal course of business and is not likely to happen again anytime soon. Certain losses and gains should never be considered extraordinary. For example, a large receivables loss due to a debtorís bankruptcy is always a possibility in the business world.
Many extraordinary losses are due to natural disasters, but you should not automatically assume that all disasters should be considered extraordinary events. A blizzard in Florida that destroys an entire orange harvest would be extraordinary, but a spring blizzard in Michigan is not so far-fetched. Likewise, a tornado in Seattle would be extraordinary, whereas one in Kansas might be considered a common occurrence.
Extraordinary gains might sound like an oxymoron, but they are reported on occasion. An example of such a gain would be the sudden death of a CEO which triggers payment on a life insurance policy.
Gains and losses from extraordinary events are reported in a separate part of the income statement, after income from both continuing and discontinued operations. Unlike regular income, extraordinary items are reported net of tax effects, meaning that losses (gains) are reduced by related tax benefits (costs). In addition, losses should be reported net of any related insurance reimbursements. As an example, letís say that XYZ Corporation, a fictitious entity, owns a building which is totally destroyed by a fire. The building has a book value of $4 million, and the insurance policy for the asset only covers $2 million of the loss. If XYZís marginal tax rate is 40%, the company would report an extraordinary loss of $1.2 million near the bottom of the income statement ($4 million minus the $2 million insurance payment minus the $800,000 tax benefit of the loss).
Transactions that could be considered unusual or infrequent, but not both, can be reported separately along with revenues and expenses from continuing operations. They should not be shown net of any tax effects.
One final note related to extraordinary events - under IFRS rules, they are not allowed to be presented on the income statement.
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