International Financial Reporting Standards (IFRS) provide guidelines for financial statement presentation and reporting. One key aspect that often raises questions is the treatment of extraordinary items in financial statements. In some accounting frameworks, extraordinary items refer to rare and unusual events that significantly impact financial performance. However, IFRS does not allow the separate presentation of extraordinary items in financial statements.
This topic explores the treatment of extraordinary items under IFRS, why they are not separately reported, and how companies disclose unusual events in financial statements.
What Are Extraordinary Items?
In accounting, extraordinary items refer to events or transactions that are both:
- Unusual in nature – Not part of the entity’s normal business operations.
- Infrequent in occurrence – Not expected to happen regularly.
Examples of events historically classified as extraordinary items under some accounting frameworks include:
- Natural disasters (earthquakes, floods, hurricanes)
- Expropriation of assets by the government
- Uninsured losses due to accidents
- Acts of war or terrorism
Does IFRS Allow Extraordinary Items?
Under IFRS, extraordinary items are not separately presented in the income statement. The standard-setters believe that all income and expenses should be classified within the normal operations of the business, even if the event is rare or unusual.
The International Accounting Standards Board (IASB) eliminated the concept of extraordinary items in IAS 1 (Presentation of Financial Statements). According to IFRS, all income and expenses must be included in the company’s profit or loss for the period and should not be reported as a separate line item.
Why Does IFRS Prohibit Extraordinary Items?
There are several reasons why IFRS does not allow the presentation of extraordinary items:
1. To Enhance Comparability
By removing extraordinary items, IFRS ensures that financial statements of different companies are comparable. Some companies may label certain transactions as extraordinary, while others may not, leading to inconsistencies in financial reporting.
2. To Prevent Misclassification
Companies might use the classification of extraordinary items to manipulate earnings by moving significant losses or gains outside normal operations. IFRS eliminates this possibility by requiring all items to be included in profit or loss.
3. To Reflect True Financial Performance
Even if a transaction is rare, it still affects the company’s financial performance. IFRS ensures that financial statements provide a complete picture without separating certain transactions as extraordinary.
How to Present Unusual and Infrequent Items Under IFRS
Although IFRS does not allow extraordinary items, it does permit companies to disclose unusual or infrequent events in the financial statements. These events should be classified within one of the following categories:
1. Income Statement (Statement of Profit or Loss and Other Comprehensive Income)
Unusual or infrequent transactions should be included within the normal line items in the income statement. For example:
- A company suffering damage from a natural disaster should report the loss under other expenses rather than as an extraordinary item.
- A one-time gain from selling a major asset should be recorded as other income.
2. Notes to Financial Statements
Companies must provide detailed disclosures about unusual or infrequent transactions in the notes to the financial statements. The disclosures should include:
- A description of the event or transaction.
- The financial impact on the company.
- Any relevant assumptions or estimates.
3. Statement of Cash Flows
IFRS requires that all cash flows be classified into three main categories:
- Operating activities
- Investing activities
- Financing activities
Any cash flow related to unusual events should be categorized appropriately. For instance, insurance proceeds from a natural disaster should be classified under investing activities if related to asset replacement.
Comparison Between IFRS and US GAAP on Extraordinary Items
Although IFRS prohibits extraordinary items, US GAAP (Generally Accepted Accounting Principles) previously allowed them but has since changed its rules.
| Feature | IFRS | US GAAP (Before 2015) | US GAAP (After 2015) |
|---|---|---|---|
| Extraordinary Items Allowed? | No | Yes | No |
| Presentation in Income Statement? | Included in profit or loss | Reported separately | Included in profit or loss |
| Disclosure in Notes? | Required for unusual events | Required for extraordinary items | Required for unusual events |
Since 2015, US GAAP has also removed the separate reporting of extraordinary items, aligning it more closely with IFRS.
Examples of Unusual Transactions and IFRS Treatment
To illustrate how IFRS treats unusual events, consider the following scenarios:
Example 1: Fire Damage to a Factory
- Event: A company’s factory suffers significant damage due to a fire.
- IFRS Treatment: The loss from fire is recorded under “Other Expenses” in the income statement. A detailed explanation is provided in the notes to the financial statements.
Example 2: Gain from Selling a Business Unit
- Event: A company sells one of its business divisions for a large profit.
- IFRS Treatment: The gain is recorded under “Other Income” in the income statement, with additional details in the notes to financial statements.
Example 3: Legal Settlement Payment
- Event: A company is required to pay a significant legal settlement due to a lawsuit.
- IFRS Treatment: The settlement is recorded under “Legal Expenses” in the income statement. Additional explanations are provided in the notes.
Key Takeaways
- IFRS does not allow the separate presentation of extraordinary items in financial statements.
- All income and expenses must be included in the profit or loss for the period, regardless of whether they are unusual or infrequent.
- Unusual events must be disclosed in the notes to the financial statements for transparency.
- IFRS aims to enhance comparability and prevent misclassification of financial transactions.
- US GAAP previously allowed extraordinary items but removed this classification in 2015, aligning with IFRS.
Under IFRS, there is no separate category for extraordinary items, as all transactions must be included in the company’s profit or loss. However, companies can still provide detailed disclosures in the financial statement notes to explain unusual or one-time events.
This approach ensures greater transparency, consistency, and comparability in financial reporting, helping investors and stakeholders make well-informed decisions.