What Are Extraordinary Gains and Losses?
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Extraordinary gains or losses are infrequent or rare business transactions that don’t reflect the normal day-to-day operations. On an income statement, extraordinary events arise that are likely one time events and non-recurring in nature.
What Is an Extraordinary Gain?
An extraordinary gain is an infrequent or unusual gain that is unlikely to happen again. Because extraordinary gains are non-recurring they are not a reliable source of income, so it’s important to ignore when projecting future financial performance. Creditors and investors expect a business to generate income from operations, not from extraordinary events.
Extraordinary Gain Example
Pretend a parent company decides to sell one of its subsidiaries. If the subsidiary sold for $1 million dollars, the parent company would recognize an extraordinary gain of $1 million dollars on its income statement. This is the perfect example of a one-time business transaction.
What Is an Extraordinary Loss?
Extraordinary losses are one-time expenses that are unlikely to ever occur again. Because they are non-recurring, you shouldn’t let an extraordinary loss in one year dictate your projections for future financial performance. Although extraordinary losses can look troubling to a creditor or investor, as long as there is a reasonable explanation for the loss, it shouldn’t severely affect their perception on a business.
Extraordinary Loss Example
A good example of an extraordinary loss would be if a business was damaged in a hurricane. The financial loss associated with repairing the damages is considered extraordinary, as natural disasters are not typically recurring. Pretend the hurricane caused a business to replace its roof. If the roof cost $50,000 to repair, the business would record a $50,000 extraordinary loss on its income statement.
Why Are Extraordinary Items Important?
Learning to identify extraordinary gains and extraordinary losses when running a business is important when performing income statement analysis. As a business owner, it’s important to know how the businesses true operations are doing.
Additionally, banks, other creditors, and investors tend to exclude extraordinary items from their debt service projections and profitability analysis.
Competent financial analysts need to be talented at using historical information to make accurate forecasts for the future. Analysts that can differentiate between recurring and non-recurring items will have a much better chance at accurately predicting the future financial performance of a company than analysts that solely look at net income.
Extraordinary Items & GAAP Accounting
Generally accepted accounting principles (GAAP) are accounting standards that consider the legalities and intricacies of business/corporate accounting. The Financial Accounting Standards Board (FASB) established these accounting standards and continue to maintain them as needed.
In 2015, the FASB discontinued the extraordinary gain and loss reporting requirements from GAAP in the United States. Prior to that, companies would spend a lot of time and effort differentiating between extraordinary and non-extraordinary items.
Although the reporting requirement for extraordinary items was removed, companies should still disclose uncommon and infrequent events. Even though it’s not an official accounting principal to differentiate between extraordinary and non-extraordinary items, finance professionals will all agree it is still an important concept in accounting and finance.