Definition
Extraordinary Item is a financial term referring to gains or losses in a company’s financial statements that are infrequent and unusual. These are significant, one-time events such as a natural disaster, expropriation, prohibitions under new regulations, or sale of an asset. These items are reported separately in a company’s income statement to ensure that the financial results for the period give an accurate picture of recurring earnings.
Phonetic
The phonetics of the keyword “Extraordinary Item” would be: ɛk-strə-ˈȯr-də-ˌner-ē ˈī-təm
Key Takeaways
- Definition: Extraordinary Items are financial events that are unusual in nature and infrequent in occurrence. They often have a significant impact on a company’s financial performance.
- Accounting Principles: According to Generally Accepted Accounting Principles (GAAP), these items are to be separated in the company’s financial statements to differentiate their effect on net income from regular business operations. However, the Financial Accounting Standards Board (FASB) eliminated the concept of extraordinary items from U.S. GAAP in 2015.
- Impact on Business Performance: Extraordinary items can have both positive or negative impacts on a company’s financial performance, and it is important for investors and stakeholders to consider them when making decisions or evaluating the company’s performance.
Importance
The term Extraordinary Item in business/finance is important because it refers to events that significantly impact a company’s financial condition and operations, which are both infrequent and unusual. It is crucial for both the company management and investors, as these items are separate in financial reporting, intending to prevent them from distorting the company’s normal earnings. These are non-recurring events, and thus, it is vital to exclude them from any trending analysis or forecasting future earnings for a more accurate reflection of the company’s financial performance. Hence, understanding the impact of these extraordinary items can provide deeper insights into the company’s true profitability and financial health.
Explanation
Extraordinary Items represent a unique category of profit or loss in a company’s income statement, specifically designed to present any uncommon or rare activities that greatly impact the company’s financial status. These are events that are not only unusual but also infrequent in nature. The main objective of noting down such items separately on a company’s financial statement is to provide a clearer and more accurate picture of the company’s ordinary income levels, recurring operating expenses, and standard business operation or performance.
Classifying and reporting certain profit or loss as extraordinary items allow both management and stakeholders to discount these effects while evaluating the financial health and operational productivity of a company. They offer a way to highlight those transactions that the management believes should not be considered in the process of assessing the ordinary and ongoing operations of the business. It helps the users of financial statements to not skew their expectations or projections based on rare events, which are not expected to recur, helping them make more informed decisions.
Examples
1. Insurance Payout for Damaged Properties: In 2005, many companies operating on the Gulf Coast of the United States suffered significant damages due to Hurricane Katrina. The insurance payouts they received for the property damages were considered extraordinary items, as these businesses wouldn’t normally earn revenue from natural disasters.
2. The Sale of a Business Division: If a large company like Cisco Systems decided to sell off one of their product lines or entire business divisions, the profit or loss from this transaction would likely be reported as an extraordinary item. This is because selling an entire part of the business is not part of the regular operations.
3. Costs from Lawsuits or Legal Settlements: In 2018, Google’s parent company, Alphabet, was hit with a record 5 billion dollar antitrust fine by the European Union. This resulted in a larger-than-normal expense that was not tied to the company’s ordinary activities. Therefore, Alphabet might categorize this fine as an extraordinary item on its income statement.
Please note: The term “Extraordinary items” was eliminated from GAAP (Generally Accepted Accounting Principles) by the Financial Accounting Standards Board (FASB) in 2015. According to the update, an unusual and/or infrequent item (which was formerly identified as an ‘extraordinary item’) is included in income from operations.
Frequently Asked Questions(FAQ)
What is an Extraordinary Item in finance and business terms?
An Extraordinary Item is a non-recurring event or transaction that stands apart from a company’s ordinary business operations. These items are considered unique and highly unlikely to happen regularly or predictably in the course of normal business operations.
Where are Extraordinary Items reported in financial statements?
Extraordinary Items are typically reported in a company’s income statement below the line for income from continuing operations. They are shown as separate line items to distinguish them from regular business revenue and expenses.
How does recognizing an Extraordinary Item affect a company’s financial reporting?
Recognizing an Extraordinary Item can significantly impact a company’s reported earnings for a given period. As it’s unique and not likely to occur again, separating this item from regular earnings helps investors and analysts to better assess a company’s normal operating performance.
Can a company decide what is an Extraordinary Item by itself?
No, according to GAAP (Generally Accepted Accounting Principles), an event or transaction should meet two criteria to be considered an Extraordinary Item: it should be both infrequent and unusual. Thus, the company cannot decide it on their own, it is clarified and guided by the accounting normative.
How does the treatment of Extraordinary Items affect investors?
Because Extraordinary Items are separated from income from continuing operations, investors can more accurately gauge a company’s regular earnings power. This can influence an investor’s decision about whether or not to invest in a company.
Why did the FASB eliminate the Extraordinary Item classification in 2015?
FASB (Financial Accounting Standards Board) eliminated the Extraordinary Item classification because they deemed it was often misinterpreted, underutilized and caused inconsistency in reporting. The change was to simplify income statement presentation and improve comparability among different companies.
Post its elimination, where are extraordinary events or transactions reported now in the income statement?
Post its elimination, extraordinary events or transactions are now reported within income from continuing operations in the income statement.
Related Finance Terms
- Non-recurring Event: These are events or transactions that are not expected to recur in the foreseeable future or are unusual in nature.
- Operating Income: This is a company’s profit after deducting operating expenses like wages, depreciation, and cost of goods sold.
- Profit and Loss Statement (P&L): Also known as the income statement, this financial document summarizes the revenues, costs, and expenses a company incurs during a specific period.
- Income Statement Impact: How an extraordinary item affects the financial results listed on a company’s income statement.
- Discontinued Operations: These are parts of a company’s operations that have been sold or disposed of. They are reported separately from the continuing operations on the company’s income statement.
