The Coastal Business Journal The Coastal Business Journal
Volume 16 Number 1 Article 2
December 2018
Extraordinary Item Classi?cation Eliminated from the Income Extraordinary Item Classi?cation Eliminated from the Income
Statement: Some Supportive Evidence Statement: Some Supportive Evidence
Mark G. McCarthy
East Carolina University
Dennis O'Reilly
East Carolina University
Douglas K. Schneider
East Carolina University
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Recommended Citation Recommended Citation
McCarthy, Mark G.; O'Reilly, Dennis; and Schneider, Douglas K. (2018) "Extraordinary Item Classi?cation
Eliminated from the Income Statement: Some Supportive Evidence,"
The Coastal Business Journal
: Vol.
16 : No. 1 , Article 2.
Available at: https://digitalcommons.coastal.edu/cbj/vol16/iss1/2
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17
Extraordinary Item Classification Eliminated from the Income Statement:
Some Supportive Evidence
Mark G. McCarthy, Department of Accounting, East Carolina University, E. 5
th
Street
Greenville, NC 27858, [email protected]
Dennis O’Reilly, Department of Accounting, East Carolina University, E. 5
th
Street
Greenville, NC 27858, [email protected]
Douglas K. Schneider, Department of Accounting, East Carolina University, E. 5
th
Street
Greenville, NC 27858, [email protected]
ABSTRACT
Accounting Standards Update 2015-01 formally eliminated the reporting of “extraordinary items” in
the income statement for fiscal years beginning after December 15, 2015. Gains and losses previously
reported as extraordinary items and presented separately below income from continuing operations, are
now reported as other gains and losses and included in income from continuing operations. The use of
the extraordinary item classification fell sharply after 2002 when gains and losses from the early
extinguishment of debt were no longer required to be reported as extraordinary items. By 2003 less than
100 publicly traded firms reported extraordinary items and in 2011 the number was only in the single
digits. Finally, in 2013 and 2014 not a single firm in our sample, drawn from the Compustat database,
reported an extraordinary item.
INTRODUCTION
In January 2015 the Financial Accounting Standards Board (FASB) published Accounting
Standards Update (ASU) 2015-01 and formally eliminated the concept of extraordinary items from
Generally Accepted Accounting Principles (GAAP). Thirteen years earlier in 2002, the International
Accounting Standard Board (IASB) and International Financial Reporting Standards (IFRS) removed
extraordinary items as a line item in the income statement. As stated in ASU 2015-01, the FASB
concluded that costs will be reduced without reducing the availability of relevant information. The
benefits of elimination include preparers no longer having to devote time and effort assessing whether
an event qualifies as extraordinary. In addition, auditors and regulators will not have to spend time on
the issue. Users will still have access to the information as companies will report material items that are
unusual in nature or occur infrequently as separate line items. However, these items are now reported as
part of continuing operations and on a pretax basis. The user will have to determine which special items
provide useful information.
The extraordinary classification had been part of United States (U.S.) accounting for more than
fifty years. In 1966 the Accounting Principles Board (APB) formally concluded in APB 9 that
extraordinary items should be shown separately from other items in the income statement. This was
ISSN: 2163-9280
Fall 2018
Volume 16, Number 1
18
based in part on the belief that the income statement is more informative if the effects of rare or unusual
events are clearly separated from those that arise from continuing events or normal operations. It was
generally agreed that management is in the best position to determine whether an item was
extraordinary. APB 30 was released in 1973 to provide additional guidance and to improve consistency
in application. This document introduced the joint requirements of “infrequent occurrence” and “unusual
in nature” before any item could be treated as extraordinary. The standard also stated that a significant
amount of judgment would be necessary on the part of management. In the ensuing years, questions
were raised as to whether the extraordinary classification and its special treatment was useful to
investors, whether the benefits of any usefulness outweighed the costs to companies in applying the
standard and whether managers opportunistically used the extraordinary classification to suit their needs.
DISAPPEARANCE OF EXTRAORDINARY ITEMS
The Compustat database of publicly traded firms was searched to identify all companies
reporting an extraordinary item during the twenty-year period 1995 through 2014. The sample includes
only U.S. firms listed on major stock exchanges that report a share price and sales greater than zero. The
sample of firms was further screened to include only firms having financial statements reported under
the industrial format (INDL) on Compustat. This restriction may have eliminated some financial
services firms.
Table 1 displays the number of firms reporting extraordinary gains and losses from 1995 to 2014.
From 1995 to 2002 the number of companies reporting an extraordinary gain or loss in a given year
ranged from 317 to 526. In 2003 there was a sharp decline in the number of firms reporting
extraordinary items, dropping from 317 in 2002 to 43 in 2003. In April 2002 the FASB released
Financial Accounting Standard (FAS) 145 (now ASC 470-50-40-2) which eliminated the requirement of
reporting gains and losses from early extinguishment of debt as an extraordinary item. This new
treatment was applicable for fiscal years beginning after May 15, 2002. FAS 145 allowed that gains and
losses from the early extinguishment of debt could still be reported as an extraordinary item, but such
transactions now had to meet the restrictive criteria, “unusual in nature” and “infrequent occurrence”.
In 2009, FAS 141(R) became effective for business combinations. Prior to 2009, negative
goodwill arising from an acquisition could result in an extraordinary gain being reported. FAS 141(R)
eliminated that treatment and required that negative goodwill be reported as a gain and included as part
of income from continuing operations.
After 2003 there is a gradual decline in the number of firms reporting extraordinary items. By
2013 there are no firms reporting extraordinary items. A noticeable trend is that from 2003 onward the
number of gains per year is greater than or equal to the number of losses, whereas prior to 2003 the
number of losses per year exceed the number of gains. By 2011 the annual number of extraordinary
items reported in the Computstat database had declined to single digits.
Table 2 presents the number of firms reporting extraordinary items classified by historical SIC
Industry codes. Consistent with the overall percentages, for the twenty-year period from
Table 1
19
Companies Reporting Extraordinary Gains or Losses
(Fiscal years 1995 through 2014)
Firms
Firms
Reporting
Reporting
Fiscal
Extraordinary
Extraordinary
Years
Gains
Losses
Total
Percentage
1995
88
319
407
11.18
1996
53
379
432
11.86
1997
61
396
457
12.55
1998
75
382
457
12.55
1999
105
339
444
12.19
2000
125
254
379
10.41
2001
167
359
526
14.45
2002
91
226
317
8.71
2003
27
16
43
1.18
2004
32
5
37
1.02
2005
25
9
34
0.93
2006
26
5
31
0.85
2007
17
5
22
0.60
2008
16
4
20
0.55
2009
11
3
14
0.38
2010
6
4
10
0.27
2011
7
1
8
0.22
2012
3
0
3
0.08
2013
0
0
0
0.00
2014
0
0
0
0.00
Total
935
2,706
3,641
Percent
25.68%
74.32%
100.00%
1995 to 2014, within each industry extraordinary losses were reported with greater frequency than were
extraordinary gains. As expected, larger industries with more companies reported more extraordinary
gains and losses. Companies in six of the sixteen classifications, Durable Manufacturers, Financial
Institutions, Insurance and Real Estate, Retail, Services, and Transportation, collectively reported 72.29
percent of the extraordinary items during that period.
Table 2
Companies Reporting Extraordinary Gains or Losses
By Industry (SIC Codes)
(Fiscal years 1995 through 2014)
20
Firms
Firms
Reporting
Reporting
Extraordinary
Extraordinary
Industry
Gains
Losses
Total
Percentage
Agriculture
3
11
14
Chemicals
18
52
70
Computers
90
145
235
Durable Manufacturers
145
380
525
Extractive Industries
52
92
144
Financial Institutions
170
240
410
Food
20
63
83
Insurance and Real Estate
86
442
528
Mining and Construction
13
52
65
Other
3
5
8
Pharmaceuticals
24
50
74
Retail
88
264
352
Services
82
371
453
Textiles and Printing
20
118
138
Transportation
78
286
364
Utilities
43
135
178
Total
935
2,706
3,641
Percent
25.68%
74.32%
100.00%
Table 3 classifies firms into one of four categories based on whether the firm reported a profit or
loss on income from continuing operations and whether an extraordinary gain or loss was reported. The
largest classification is firms reporting a profit on income from continuing operations and an
extraordinary loss. This is 2,029 firms, or 55.7 percent, more than half of the total firms reporting
extraordinary items. The second largest group is firms reporting a loss on income from continuing
operations and an extraordinary loss, 677 companies or 18.6 percent of the total number of firms. Since
fewer firms reported extraordinary gains than losses, those percentages are smaller with 10.2 percent
reporting extraordinary gains and a loss on income from continuing operations and 15.5 percent
reporting extraordinary gains and a profit on income from continuing operations.
Table 3
Companies Reporting Extraordinary Gains or Losses
By Profit or Loss on Income from Continuing Operations
(Fiscal Years 1995 through 2014)
Firms
Firms
21
Reporting
Reporting
Extraordinary
Extraordinary
Income from continuing operations
Gains
Losses
Total
Profit
563
2,029
2,592
Percentage
15.5%
55.7%
71.2%
Loss
372
677
1,049
Percentage
10.2%
18.6%
28.8%
Total
935
2,706
3,641
Percentage
25.7%
74.3%
100%
The financial statement impact of extraordinary gains and losses relative to income from
continuing operations is presented in Table 4. The ratio or percentage of extraordinary gains and losses
to both profit and loss on income from continuing operations is displayed in Table 4. Due to the
significant influence of outliers, the means and standard deviations are not presented, only the quartile
values are listed.
The largest median of an extraordinary item as a percentage of income is firms reporting
extraordinary gains and a loss from continuing operations. For this group of firms the median amount
was 15.8 percent. This means that half of the companies reported an extraordinary gain that was 15.8
percent or more than the reported loss from continuing operations. The next highest median value was
12.0 percent for firms reporting an extraordinary loss as a percentage of net loss from continuing
operations. For firms reporting a profit on income from continuing operations, the median was 8.5
percent of income from continuing operations for extraordinary gains and 6.8 percent of income from
continuing operations for extraordinary losses. If a reported amount is considered material at the five
percent or greater level, then the percentage of the relationship between extraordinary items and the
reported profit/loss from continuing operations would be material for over half of the firms.
An initial explanation for the majority of extraordinary items consisting of losses could be that
those events that were infrequent and unusual tended to be events that were negative occurrences, such
as physical damage to companies’ assets or unanticipated business events that generated financial losses.
However, one other potential partial explanation for the preponderance of losses reported as
extraordinary items is that companies’ management may have had a motive to do so. Previous research
on discontinued operations, another special reporting line on the income statement treated the same as
extraordinary items, provided evidence that management would favor reporting some operating losses as
being from discontinued operations so that such losses would be excluded from core earnings, a number
more closely followed than the earnings figure that include the results of discontinued operations (Barua
et al. 2010). Thus, the core earnings of the company would be inflated by shifting operating losses into
discontinued operations. This similarity of extraordinary items to discontinued operations raises the
question as to whether management chose to categorize some losses as extraordinary that might have
been more appropriately categorized as operating losses. Exploring this issue is beyond the scope of this
paper
22
Table 4
Extraordinary Gains or Losses as a Percentage of
Positive or Negative Income from Continuing Operations
(Fiscal Years 1995 through 2014)
Extraordinary Item:
Gain
Loss
Gain
Loss
Income from Continuing Operations:
Profit
Profit
Loss
Loss
N
563
2,029
372
677
75% Q3
31.6%
21.2%
72.4%
43.7%
50% Median
8.5%
6.8%
15.8%
12.0%
25% Q1
2.0%
2.3%
4.4%
3.7%
To the extent that companies were using the extraordinary item classification for the purpose of
enhancing operating earnings, then it would provide support for the elimination of extraordinary items
since it was facilitating manipulation of earning numbers and possibly undermining the usefulness of
financial reporting.
FUTURE RESEARCH
Whether the elimination of reporting some gains and losses as extraordinary items results in
more valuable or higher quality information is an open question. The present study does not address
whether companies were able to inappropriately shift gains and losses from operating income to the
extraordinary classification. Future researchers could explore this issue by adopting the methodology
that Barua et al. (2010) applied to their study of the reporting of discontinued operations.
As discussed earlier there were several significant changes to accounting for extraordinary items
during the time-period examined in this study (e.g., reporting early extinguishment of debt in
extraordinary items was eliminated as of 2003). Future research could examine whether the value
relevance of the information reported changed as the reporting regimes changed.
SUMMARY
The analysis in this article indicates that the reporting of extraordinary gains and losses had
almost ceased to be reported by firms in recent years. In earlier years when it was more common, it
arguably provided the opportunity, if not the intent, to classify some losses away from income from
continuing operations and into extraordinary items, thus enhancing the amount of income from
continuing operations, an amount widely followed by the investment community. Extraordinary losses
were reported approximately three times as often as extraordinary gains.
In many cases, the gains and losses reported were of significant magnitude relative to the size of
the company. More than one half of the firms reported extraordinary gains or losses that exceeded five
percent of their profit or loss from continuing operations.
23
Prior to 2005, there were three items reported on the income statement after income from
continuing operations: 1) discontinued operations; 2) extraordinary items; and 3) cumulative effect of
change in accounting principle. In 2005, reporting the cumulative effect was eliminated and in 2015
reporting extraordinary items was eliminated. Recently, the scope of discontinued operations has been
narrowed. More and more accounting information is being classified as part of income from continuing
operations, core earnings, where it is up to the user of the financial statements to decide the usefulness of
the information. Now there are fewer opportunities for management to classify items, especially losses,
out of core earnings and into special reporting.
24
REFERENCES
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Income and the Treatment of Extraordinary Items and Prior Period Adjustments; II—Computation and
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r=true
Accounting Principles Board (1973, June) APB 30: Reporting the Results of Operations—Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions (Norwalk, CT).
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Barua, A., Lin, S., and Sbaraglia, A.M. (2010, September) Earnings Management Using Discontinued
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No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13,
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r=true
Financial Accounting Standards Board (2015, January) Accounting Standards Update No. 2015-01.
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