Historically, to be classified as an extraordinary item in financial statements under U.S. Generally Accepted Accounting Principles (GAAP), an event or transaction had to meet two stringent criteria: it must be of an unusual nature and occur infrequently. These items were distinguished by their exceptional character and rarity, reflecting events outside the typical operations of a business.
It is crucial to understand that while these criteria defined extraordinary items for many years, the concept of a separate "extraordinary item" presentation on the income statement has since been eliminated from U.S. GAAP by the Financial Accounting Standards Board (FASB) as of Accounting Standards Update (ASU) 2015-01. However, the underlying concepts of unusual and infrequent occurrences remain relevant for other types of financial disclosures.
Historical Criteria for Extraordinary Items
For an item to have been classified as extraordinary, it had to satisfy both of the following conditions:
1. Unusual Nature
An event or transaction was considered to be of an unusual nature if it was highly abnormal and clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity. This assessment was made considering the environment in which the entity operates. What might be unusual for one company could be a regular occurrence for another.
- Key aspects of unusual nature:
- It was not expected to be part of the company's normal business risks.
- It did not result from customary business activities.
- Its cause was outside the control of management or the company.
2. Infrequency of Occurrence
An event or transaction was deemed to be infrequent of occurrence if it was not reasonably expected to recur in the foreseeable future, taking into account the environment in which the entity operates. This criterion emphasized that the event should be highly unlikely to happen again, rather than just being something that doesn't happen every year.
- Key aspects of infrequency of occurrence:
- It was not anticipated to happen again in the company's operating environment.
- It was a one-time, non-recurring event.
- The likelihood of its repetition was remote.
Summary of Criteria
The table below summarizes the two defining characteristics for classifying an event as extraordinary:
Criterion | Description |
---|---|
Unusual Nature | The underlying event or transaction is highly abnormal and clearly unrelated to, or only incidentally related to, the ordinary activities of the entity. |
Infrequency of Occurrence | The event or transaction is not reasonably expected to recur in the foreseeable future. |
Current Treatment in U.S. GAAP
With the elimination of extraordinary items, events and transactions that would have previously met these criteria are now typically reported differently in financial statements. Companies are still required to report items that are unusual or infrequent (but not necessarily both) as separate line items in the income statement within continuing operations. This is often done to highlight their non-recurring impact on financial performance.
- Examples of events that were once classified as extraordinary (and now separately disclosed if material):
- Major natural disasters (e.g., a severe earthquake or flood) that are not typical for the company's geographical location or industry.
- Expropriation of assets by a foreign government.
- Prohibitions under newly enacted laws or regulations, like new environmental restrictions.
The objective of separating these items, then and now, is to provide financial statement users with clearer insights into a company's sustainable core operating performance by distinguishing it from rare or unique events. This practice enhances the predictive value of financial reporting, allowing investors and analysts to better understand the recurring profitability of a business.
For detailed information on current reporting standards, refer to official accounting guidance from bodies like the Financial Accounting Standards Board (FASB).