Extraordinary Items vs. Nonrecurring Items: An Overview
Financial analysts and investors pore over the numbers in a company’s financial reports in an attempt to make reasonably accurate predictions of its future performance. To do so, they need to know which numbers are important to the company’s prospects and which are less relevant.
Extraordinary items and nonrecurring items are examples of business expenses that had a significant impact on the company’s current financial report but will not appear in its future reports.
That doesn’t mean they are irrelevant. Earthquake damage, considered an extraordinary item, can have a lasting impact on a company’s expenditures. Restructuring charges, a non-recurring item, can alter a company’s financial performance for better or worse.
Otherwise, the distinctions between the two types of costs are subtle and even subjective.
Key Takeaways
- An extraordinary item in a company’s financial statements is a gain or loss that is unlikely to happen again.
- A nonrecurring item refers to an infrequent or unusual item that appears on a company’s financial statements.
- The difference between extraordinary items and nonrecurring items is often subjective, and therefore extraordinary items are often lumped under nonrecurring items.
- The International Financial Reporting Standards (IFRS) does not recognize extraordinary items, only nonrecurring items.
- Generally accepted accounting principles (GAAP) make a greater distinction between the two but this has become less common as the tax advantages of extraordinary items have disappeared.
Extraordinary Items
Extraordinary items are gains or losses in a company’s financial statements that are infrequent and unusual. An item is deemed extraordinary if it is not part of a company’s ordinary, day-to-day operations but that had a material financial impact on the company.
A material impact means that it has a significant effect on a firm’s profitability and should, therefore, be broken out separately.
Detailed explanations of an extraordinary item must be included in the notes to the financial statements in a company’s annual reports or financial filings with the Securities and Exchange Commission (SEC). It represents a one-time expense involving an unpredictable event.
Examples of extraordinary items include damage from natural disasters such as earthquakes and hurricanes, gains or losses from the early repayment of debt, and write-offs of intangible assets.
Important
International Financial Reporting Standards (IFRS) does not recognize the concept of an extraordinary item, which has led to the practice of classifying extraordinary items as separate from nonrecurring items to become obsolete.
Nonrecurring Items
An entry for a nonrecurring item on a company’s financial statements indicates a business expense that is unusual and is unlikely to happen again.
There are many examples of nonrecurring items. They may include litigation charges, charges related to laying off workers, restructuring charges, gains or losses from the sale of assets, write-offs or write-downs related to business operations, and losses related to shutting down a business unit.
Special Considerations
Accountants spend considerable time determining whether an item should be qualified as extraordinary or nonrecurring. Financial Accounting Standards Board (FASB) Statement No.145 helps stipulate the accounting charges that can rightfully be considered extraordinary.
It is important to note that International Financial Reporting Standards (IFRS), which are not used in the U.S. but are used by many other countries, do not recognize the concept of an extraordinary item.
U.S. generally accepted accounting principles (GAAP) make more of a distinction, such as with the extraordinary item discussion above that covered the unusual and infrequent differences.
In this respect, a nonrecurring item might qualify as an unusual or infrequent item, but not both.
A Vanishing Distinction
Since 2015, changes in the GAAP standards have made any differences between extraordinary items and nonrecurring items largely irrelevant.
Before the change, extraordinary items received beneficial tax treatment in comparison to non-extraordinary items under GAAP. These tax treatments have vanished for the most part, making the distinction between extraordinary items and non-extraordinary items unnecessary, particularly since defining an extraordinary item was largely a subjective exercise.
Most financial reporting and analysis tends to lump one-time items together and focus on separating them from those that are likely to recur in the future. In many cases, this is fine because the most important exercise in analyzing a firm’s financial statements is separating recurring from nonrecurring items.
However, there are differences to note. For instance, nonrecurring items are recorded under operating expenses in the net income statement. By contrast, extraordinary items are most commonly listed after the bottom line net income figure. They are also usually provided after taxes and must be explained in the notes to the financial statements.
Where Can I Find Extraordinary and Unusual Items in a Financial Report?
Extraordinary items are no longer listed on the income statement but appear separately, usually after income from continuing operations. The item will be explained in the notes.
Non-recurring items are usually listed in the income statement under indirect costs.
How Do Non-Recurring Items Affect a Company’s EPS?
Any non-recurring and extraordinary charges on a company’s financial statement are excluded from its earnings per share (EPS) calculation. Both non-recurring items and extraordinary items are by definition significant but unlikely to reoccur. As such, they would skew the EPS number, which is used as a measure of the company’s financial performance.
What Is an ‘Extraordinary’ Item in a Financial Report?
An extraordinary item, in a financial statement, is an unusual event that is unlikely to reoccur but is significant enough in dollar terms to be noted in the report. A court settlement in a class-action suit would be an example.
The Bottom Line
The differences between entraordinary items and nonrecurring items are so subtle as to be irrelevant to most investors. Both are costs related to highly unusual if not unique events. Both entail considerable amounts of money. In either case, it’s wise to identify the source of the expense to determine its potential impact on the company’s future.
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