When a business incurs a loss that is outside of their control, accountants designate it an extraordinary item in the financial statements. What this means is that it’s a material event not related to the activities of the business, which are infrequent in nature. They are thus typically not expected to occur again.
Examples of extraordinary items include damages from natural disasters such as floods, earthquakes, or hurricanes. It can also be expropriations by governments, new laws which prohibit certain activities or products, and certain kinds of losses from extinguishing long term debt. Reporting extraordinary events is surrounded by certain rules provided for by the FASB, or the financial accounting standards board. These include the rule that companies cannot claim extraordinary losses due to say, earthquakes for example, if they operate in an area that frequently has earthquakes, such as California.
Extraordinary items can sometimes be difficult to classify. Examples of non-extraordinary items include losses on abandoning property or equipment in connection with a business, write-downs of such things as receivables and securities, and losses from strikes by employees. If an event is either infrequent in nature or unusual, it may not qualify for extraordinary item treatment. This is because the FASB requires that it be infrequent AND unusual. Take, for example, write-downs of receivables. Even though it may happen from time to time, it is not an infrequent or unusual event. It’s simply a risk in operating a business and extending credit to customers.
Immaterial amounts of extraordinary losses may not be able to be classified as such, because they won’t have a large impact for reporting purposes. Companies will sometimes try to hide that fact by taking the loss in a different category. If, for example, prohibition of a certain product in an international branch of a company by a foreign government results in decreased investment in similar external companies, it would behoove a company to avoid reporting it as an extraordinary item due to the fact that increased losses may be sustained to loss of investment capital. It’s easy to see why reporting of extraordinary items may not always be clear-cut, yet convergence with international standards of accounting may help to make it more transparent.
The CPA Journal, February 2007
“Extraordinary Items: Time to Eliminate the Classification” by Marcos Massoud, Cecily Raiborn, and Joseph Humphrey