© 2000 John Petroff
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© 2000 John Petroff |
3)- Extraordinary items
Showing amounts as extraordinary
items in an income statement is an attempt by management to convey
an image that the rest of the income statement reflects earnings
from normal operations. In the United
States, accounting rules have oscillated between one extreme of
allowing almost nothing as extraordinary (known as the "all
inclusive" concept), to the other extreme of practically
giving management a free hand (known as the "current operating
performance" concept). Today the
rule is somewhere in the middle: items that are to be considered
as extraordinary, must be a) unusual in nature and b) infrequent
in occurrence. Under this definition, even write-off of defective
equipment, closing of plant, abandonment of property, and effects
of strikes are considered as normal business. The presentation
of these items can however be labeled as gain or loss from discontinued
operations and shown separate from result from continuing operations.
What remains as extraordinary is truly
unusual and infrequent such as
- consequences of a natural catastrophe
- expropriation
- results of major litigation
- effect of major changes in accounting
- gains from retirement of bonds (other than retirement that was
initially stipulated)
For an outside analyst or investor, it is certain that management should be held accountable for all events in the long run, however unusual or infrequent they may be. Even dealing with natural catastrophes must be part of managerial responsibility. Not that managers should acquire crystal balls. But they ought to secure appropriate insurance, avoid excessive risk, or take other such protective steps. Yet, there is something to be said for showing as earnings from normal operations only what is truly from regular activity for that particular year. There is plenty of distortions in earning as it is. Forcing back many events that are unusual but recurring, or infrequent but a by-product of normal activity, is another important source of distortion. Take for instance the case of a publisher that sells a large proportion of books abroad, and that has often sizeable gains from foreign exchange that offset operating losses; any comparison of such earnings with strictly domestic profitable publishers is distorted and obviously questionable. Or putting it another way, the analyst must look for such distortions and give the events their proper weight.
See review questions Q-13A3.1 through Q-13A3.8.
See research assignments R-13A3.1 through R-13A3.3.
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