EXTRAORDINARY ITEMS
Income or expenses that arise from event or transactions that clearly distinct from the ordinary activities of the enterprise and therefore, are not expected to recur frequently and regularly.
Extraordinary items should be disclosed in the statement of profit and loss as a part of net profit of loss for the period.
The nature and amount of each extraordinary item should be separately disclosed in the statement of profit of loss in a manner that its impact on current profit and loss can be perceived.
Whether an event or transaction is clearly distinct from ordinary activities of the enterprise is determined by the nature of the event or transaction in relation to the business ordinarily carried on by the enterprise rather than the frequency with such events are expected .
Therefore, an event or transaction may be extraordinary for one enterprise but not so for other enterprise because of the differences between their respective ordinary activities.
For example, losses sustained as a result of an earthquake may qualify as extraordinary item for many enterprises. However, claims from policyholders arising from an earthquake do not qualify as extraordinary item from an insurance enterprise that insures against such risks.
Examples of event or transactions that generally give rise to extraordinary items for most enterprise are:
- Attachment of property of the enterprise.
- A earthquake.
TREATMENT OF COVID-19 LOSS
(WHETHER TO TREAT IT AS EXCEPTIONAL OR EXTRA ORDINARY ITEM)
Business is passing through an unprecedented time and incurring huge direct and indirect costs due to Covid 19 pandemic. Lockdown protocols have led to severe supply chain disruptions and labour shortages, hurting both the top and the bottom lines of almost all companies. Writing offs inventory with low shelf life or high storage costs or inadequate demand is a common news. Payments from customers are delayed, adding the burden of interest and increasing the chances of bad debts or loan defaults.
Should the losses arising out of COVID-19 lockdown be categorized as ordinary or should it be treated as extraordinary or exceptional losses is the question which will not only determine the comparability of internal (with previous periods) and external (with industry peers) financial statements but also impact the interest of investors, due diligence and banker’s credit limits..
ICAI’s Advisories and Guidance Notes for Auditors on Covid 19 Reporting: As a matter of practice whenever, there is any confusion in reporting of transactions, we refer to the Accounting Standards issued by Institute of Chartered Accountants of India (ICAI) as these standards deal comprehensively with recognition, measurement, presentation and disclosure requirements of almost all events and transactions in business. These advisory and guidance notes highlight impact of Coronavirus on Financial Reporting.
Going in-depth, AS 5 Standard defines, Ordinary activities and ‘extraordinary items’ in para 4 as:
Ordinary activities are any activities which are undertaken by an enterprise as part of its business and such related activities in which the enterprise engages in furtherance of, incidental to, or arising from these activities.
Extraordinary items are income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly.
So, AS-5 while defining the ordinary and extra ordinary activities makes it clear that if an event or transaction is clearly “rare” and not expected recur frequently, and then it had to be separated from the transactions from ordinary operations.
Exceptional Items: When items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.
THE STORY BEHIND THE SAME
Extraordinary Items deleted from IFRS, US GAAP and Ind AS 1: It is worthwhile to highlight here that the International Accounting Standards Board, (IASB), erased the concept of extraordinary items under International Financial Reporting Standards (IFRS) in 2002. Similarly, Financial Accounting Standards Board (FASB) on January 9, 2015, via Accounting Standards Update (ASU) No. 2015-01, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20) Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items removed with the concept of extraordinary items from US GAAP. When FASB was discussing about eliminating extraordinary items, it found that it was extremely rare for companies to report extraordinary items, but auditors and regulators had to spend a lot of time in deciding if an event required a special reporting. Moreover, it noted that in the past, events such as terrorist attacks of September 11, 2001, and the Japanese tsunami in 2011 had also not been considered by FASB as extraordinary items.
On being questioned as to why 9/11 should not be considered as extraordinary event, Timothy Lucas, then chairman of the Emerging Issues Task Force (EITF) for FASB said “The extraordinary item treatment could never hope to capture the full event,” “The airlines lost three days of revenue, but lost revenue is not a cost that can be included in an extraordinary item, so the airlines would have had to break that out. We were not going to accomplish anything useful by having extraordinary item treatment of this event.”
As per a statement issued by FASB “Any approach to extraordinary item accounting would include only a part, perhaps a relatively small part, of the real effect”. The EITF concluded that showing part of the effect as an ‘extraordinary item’ would hinder, rather than help, effective communication.
The removal of extraordinary event concept from IFRS and US-GAAP was followed in India through Para 87 of Ind AS 1 which was drafted to direct that “An entity shall not present any items of income or expense as extraordinary items, in the statement of profit and loss or in the notes”.
Now the situation is that even though AS 5 requires the classification and disclosure of extraordinary items, such a disclosure has been eliminated long ago from US GAAP, IFRS and Ind AS 1.
Schedule III of Companies Act,2013: Another difference which is often discussed between extraordinary items and exceptional items is the disclosure requirements specified in Schedule III to the Companies Act,1956. The Schedule at S.No VI and VIII requires disclosure of exceptional and extraordinary items respectively. An extract of the Part B of the schedule is placed at the Annexure 1.
While the above para discusses on elimination of extraordinary items, exceptional items included in all accounting standards as can be understood as ordinary items which are infrequent but not unusual. A thin difference between extraordinary and exceptional is the “unusualness “or “rareness” or “a clear distinction from the ordinary activities”. Considering the Covid 19 scenario, the losses cannot be qualified as extraordinary items, but yet they are definitely exceptional. They are ordinary and infrequent. This categorization of losses as ordinary but exceptional can also aid significantly in tax assessments for direct and indirect taxes.
CONCLUSION
Covid19 losses are significant even though they fall within the ordinary activities of business, but considering their size, they undoubtedly need to be disclosed separately to give a true and fair view to the financial statements. These losses are advised to be positioned as “exceptional items” in the income statement at S.No. VI of Schedule III of the Companies Act, 2013.
It is pertinent to mention that a separate disclosure of actual and potential losses arising due to Covid 19 lockdown is definitely required considering the size of losses, the same may be termed as “exceptional” and not “extraordinary”. Both AS-5 and Schedule III still deal with “extraordinary items”, though the concept has become redundant as it has been removed from US GAAP and Para 87 of Ind AS 1 clearly provides that no entity shall present any items of income or expense as extraordinary items, in the statement of profit and loss or in the notes. Based on above, it would not be advisable to report such losses as extraordinary items. Covid 19 losses and expenses are exceptional and should be disclosed as exceptional items in line with para 14 of AS-5 and para 98 of Ind AS 1.