Extraordinary item

What Is Extraordinary Item?

An extraordinary item, in the context of financial accounting, historically referred to an event or transaction that was both unusual in nature and infrequent in occurrence for a company. These items were considered distinct from a company's ordinary business activities and were reported separately on the income statement to provide a clearer view of its core financial performance. The concept of an extraordinary item falls under the broader category of financial accounting principles that dictate how financial transactions are recorded and presented in a company's financial statements.

History and Origin

The concept of extraordinary items has a long history in financial reporting. In the United States, the criteria for classifying an event as an extraordinary item were formally established in 1973 by the Accounting Principles Board (APB) Opinion No. 30, which required an event to be both "unusual in nature" and "infrequent in occurrence" within the environment in which the entity operated.¹⁹ This distinction was intended to help users of financial statements understand the impact of highly unusual, one-off events that were not expected to recur.

However, the application of this definition proved challenging and led to infrequent use.¹⁸ Over time, the formal reporting of extraordinary items became increasingly rare, with very few companies reporting them.¹⁷ The International Accounting Standards Board (IASB) eliminated the concept of extraordinary items from International Financial Reporting Standards (IFRS) in 2002, with the change effective in 2005.¹⁶,¹⁵

To simplify Generally Accepted Accounting Principles (GAAP) and align with international standards, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-01, "Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items," in January 2015.¹⁴ This update formally eliminated the requirement to classify and report extraordinary items separately in financial statements for fiscal years beginning after December 15, 2015.¹³ The FASB noted that the benefits of eliminating the concept included reducing costs and complexity for preparers, auditors, and regulators, as the assessment of whether an item qualified as extraordinary was time-consuming and often subjective.¹²,¹¹

Key Takeaways

• Historically, an extraordinary item was an event or transaction deemed both unusual in nature and infrequent in occurrence.
• These items were previously presented separately on the income statement, net of tax, after income from continuing operations.
• The concept of extraordinary items was formally eliminated from U.S. Generally Accepted Accounting Principles (GAAP) by the Financial Accounting Standards Board (FASB) in 2015.
• While the formal classification no longer exists, companies are still required to report material items that are unusual or infrequent, but they are now typically included within income from continuing operations.
• The elimination aimed to simplify financial reporting and align U.S. GAAP with International Financial Reporting Standards (IFRS).

Interpreting the Extraordinary Item

Before their elimination, extraordinary items were interpreted as events that were truly outside the normal scope of a company's operations, providing users of financial statements with a clearer view of core profitability. Analysts often excluded extraordinary items when evaluating a company's recurring earnings, believing these one-time events could distort the true picture of operational net income.

While the separate classification of an extraordinary item no longer exists, unusual or infrequent events still occur and must be disclosed. Today, these items are typically reported as separate line items within income from continuing operations or detailed in the notes to the financial statements. This places the onus on the user of the financial statements to identify and assess the impact of these non-recurring events on a company's performance.

Hypothetical Example

Consider a hypothetical company, "Widgets Inc.," in 2014, before the elimination of the extraordinary item classification. Widgets Inc. operates a manufacturing plant that is severely damaged by a once-in-a-century earthquake, an event highly unusual for its geographic location and not reasonably expected to recur. The earthquake causes a loss of $10 million, which is material to the company's financial results.

If Widgets Inc. had $50 million in revenue and $30 million in normal operating expenses, resulting in $20 million in income from continuing operations, the extraordinary loss would have been presented as follows on its income statement (assuming a 25% tax rate on the loss):

Widgets Inc. (Simplified Income Statement - 2014)

Income from Continuing Operations: $20,000,000
Extraordinary Loss (Net of Tax): ($7,500,000)

• ($10,000,000 loss - $2,500,000 tax benefit)
  Net Income: $12,500,000

This separate presentation would have allowed investors and analysts to easily distinguish the loss from the company's ordinary operational results and understand its impact on total earnings per share (EPS).

Practical Applications

Historically, the separate reporting of an extraordinary item allowed for a clearer distinction between a company's core operational performance and the impact of highly unusual, non-recurring events. This was particularly useful for financial analysis, as analysts often sought to exclude these one-off items to better forecast future earnings and evaluate a company's sustainable profitability.

Today, while the specific extraordinary item classification is gone, companies still encounter events that are unusual or infrequent. These events, such as gains or losses from a significant lawsuit, the sale of a major business segment, or the impact of natural disasters, are now typically reported within the "other income and expenses" section or as separate line items within a company's income from continuing operations. Auditors ensure that such material items are appropriately disclosed, either on the face of the financial statements or in the accompanying notes, enabling shareholders and other stakeholders to understand their nature and financial effect. Financial analysts may still adjust reported income to remove these non-recurring items when assessing a company's ongoing performance.¹⁰

Limitations and Criticisms

The primary limitations and criticisms of the extraordinary item classification, which ultimately led to its elimination, revolved around its subjectivity and rarity. Defining what constituted "unusual" and "infrequent" was often a matter of interpretation, leading to inconsistencies in reporting across different companies and industries.⁹,⁸ For instance, a natural disaster might be considered infrequent in one region but somewhat more common in another, making classification difficult.⁷

Furthermore, the stringent criteria meant that very few events actually qualified as an extraordinary item.⁶,⁵ This rarity meant that preparers of financial statements, auditors, and regulators spent time and resources assessing events that rarely met the threshold, adding unnecessary cost and complexity to financial reporting.⁴ The move to eliminate the extraordinary item classification in U.S. Generally Accepted Accounting Principles (GAAP) also brought it into alignment with International Financial Reporting Standards (IFRS), which had previously abolished the concept, aiming for greater convergence and comparability in global financial reporting.³,² The American Accounting Association highlights that despite nearly a century of debate, no authoritative body ever managed to create a universally acceptable definition.¹

Extraordinary Item vs. Nonrecurring Item

Historically, the distinction between an extraordinary item and a nonrecurring item was a key point in financial reporting under U.S. GAAP. An extraordinary item was defined by strict criteria: it had to be both unusual in nature and infrequent in occurrence. This meant the event was highly abnormal and not expected to happen again in the foreseeable future, given the company's operating environment. Examples often cited included certain losses from expropriations of assets or major natural disasters.

A nonrecurring item, on the other hand, was a broader category for events that were unusual or infrequent, but not necessarily both. These items might be part of a company's normal business activities but occurred irregularly, such as restructuring charges, gains or losses from asset sales, or impairment charges. While significant, they didn't meet the extremely high bar for extraordinary classification. The main confusion arose because both types of items were one-time or infrequent events, potentially distorting a company's core operating performance. However, with the elimination of the formal extraordinary item classification in 2015, the distinction is now largely obsolete in U.S. GAAP, with most such events now categorized more generally as "unusual or infrequent items" within continuing operations.

FAQs

Is an extraordinary item still used today in financial reporting?

No, the formal concept of an extraordinary item was eliminated from U.S. Generally Accepted Accounting Principles (GAAP) in 2015 by the Financial Accounting Standards Board (FASB). It is also not recognized under International Financial Reporting Standards (IFRS). Companies no longer present events as extraordinary items separately on the income statement.

What was the purpose of an extraordinary item?

The purpose was to segregate and highlight gains or losses that were truly abnormal and highly unlikely to recur. This was intended to help users of financial statements, such as investors and analysts, differentiate a company's core, recurring operating results from the impact of rare, one-off events, thereby providing a clearer picture of sustainable performance.

Where are events that used to be considered extraordinary items reported now?

Events that would have previously qualified as an extraordinary item are now typically reported as part of income from continuing operations. They are often presented as separate line items within "other income and expenses" or are disclosed in detail in the notes to the financial statements if they are material and deemed unusual or infrequent. Users must now actively identify and interpret these items themselves when assessing a company's underlying cash flow and performance.