Extraordinary Item
Definition
An Extraordinary Item refers to a significant, unusual, and infrequent event that has a considerable impact on a company’s financial statements. Because these events are rare and do not occur in the normal course of business, they must be separately disclosed to shareholders in the company’s annual or quarterly reports. This aids stakeholders in distinguishing between regular operating income and income derived from these extraordinary events.
Examples
- Write-off of a Division: The company decides to completely shut down one of its operating divisions and writes off all related assets and liabilities.
- Acquisition of Another Company: A significant purchase of another business that is not a routine transaction for the company.
- Sale of a Large Amount of Real Estate: Selling a large property, such as a main operating facility, that significantly impacts financial results.
- Uncovering Employee Fraud: Discovering and addressing significant employee fraud that has a detrimental effect on the company’s financial health.
Frequently Asked Questions (FAQs)
Q1: Why do companies have to report extraordinary items separately?
- A1: They are separated to provide clarity and to help stakeholders understand the true operational performance of the company without the distortion caused by significant, nonrecurring events.
Q2: How are extraordinary items treated on financial statements?
- A2: Extraordinary items are listed separately in the income statement, net of tax, so their financial impact is clear and distinct from normal operational results.
Q3: Can extraordinary items be both gains and losses?
- A3: Yes, they can be either gains (such as a profit from the sale of a large asset) or losses (such as the costs associated with closing a division).
Q4: How frequently do extraordinary items occur?
- A4: By definition, extraordinary items are rare since they are both unusual and infrequent occurrences in the normal business operations.
Related Terms
- Nonrecurring Costs: Expenses or charges that are not expected to happen regularly in the course of business.
- Annual Report: A comprehensive report on a company’s activities and financial performance throughout the preceding year.
- Quarterly Report: A summary of financial performance, produced every three months.
- Materiality: The significance of an event or information in the context of the company’s financial statements.
Online References
- Investopedia: Extraordinary Items Definition
- Financial Accounting Standards Board (FASB)
- SEC Filings on EDGAR
Suggested Books for Further Studies
- “Financial Accounting Theory and Analysis: Text and Cases” by Richard G. Schroeder and Myrtle W. Clark
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Financial Statement Analysis and Security Valuation” by Stephen Penman
Fundamentals of Extraordinary Item: Accounting Basics Quiz
### Are extraordinary items considered frequent components of a company's income?
- [ ] Yes, they occur regularly and are part of usual business operations.
- [x] No, they are rare and infrequent.
- [ ] Yes, they can occur in any fiscal reporting period.
- [ ] They should not be disclosed in financial statements.
> **Explanation:** Extraordinary items are defined by their rarity and infrequency, distinguishing them from regular operational activities.
### How are extraordinary items reported in financial statements?
- [x] Separately, net of tax.
- [ ] As operational income.
- [ ] Under other comprehensive income.
- [ ] They are not reported separately.
> **Explanation:** Extraordinary items are reported separately in the income statement, net of tax, to maintain clarity of the financial impact.
### Can extraordinary items result in financial gains for a company?
- [x] Yes, they can result in either gains or losses.
- [ ] No, they are always losses.
- [ ] Only if approved by shareholders.
- [ ] It depends on the nature of the item.
> **Explanation:** Extraordinary items can lead to both financial gains and losses, reflecting significant nonrecurring events.
### How does the discovery of employee fraud affecting financial conditions classify in accounting?
- [ ] An everyday business activity.
- [x] An extraordinary item.
- [ ] A regular operational expense.
- [ ] An immaterial event.
> **Explanation:** Discovery of employee fraud affecting the financial condition is classified as an extraordinary item as it is significant, unusual, and nonrecurring.
### Is the acquisition of another company typically considered an extraordinary item?
- [x] Yes, if it is a significant, nonrecurring event.
- [ ] No, acquisitions are regular operations.
- [ ] Only in the real estate sector.
- [ ] If it severely impacts the financial condition.
> **Explanation:** Significant acquisitions that are unusual and infrequent are considered extraordinary items.
### What must extraordinary items be accompanied by in reporting?
- [x] An explanation to shareholders.
- [ ] Approval from government authorities.
- [ ] Regular operational costs.
- [ ] Deferred taxation.
> **Explanation:** Extraordinary items must be clearly explained to shareholders in the financial reports to provide transparency.
### When is a large sale of real estate considered an extraordinary item?
- [x] When it significantly impacts financial results.
- [ ] When it is part of the company's regular activities.
- [ ] If it generates substantial income.
- [ ] If it is sanctioned by the board.
> **Explanation:** A large property sale that notably impacts the company’s financial results is considered extraordinary.
### How important is the concept of materiality in classifying extraordinary items?
- [x] Highly important.
- [ ] Not relevant.
- [ ] Somewhat important.
- [ ] It varies by industry.
> **Explanation:** The concept of materiality is important as it determines whether an event significantly affects the company’s financial statements and needs separate disclosure.
### What financial report showcases extraordinary items?
- [x] Income Statement.
- [ ] Balance Sheet.
- [ ] Cash Flow Statement.
- [ ] Statement of Shareholder Equity.
> **Explanation:** Extraordinary items are showcased on the income statement, making their financial impact clear.
### Why is extraordinary items' disclosure mandatory?
- [x] For transparent financial reporting.
- [ ] Due to tax regulations.
- [ ] For investment decision making.
- [ ] According to company policy.
> **Explanation:** Mandatory disclosure of extraordinary items ensures transparent financial reporting, providing stakeholders with an accurate understanding of nonrecurring events.
Thank you for delving into the intricacies of extraordinary items with this detailed guide and quiz. Continue to explore and excel in your financial knowledge!
