Financial Reporting of Non-recurring Items
Discontinued Operations
Under both IFRS and US GAAP, a discontinued operation represents a component of an entity that has been disposed of or is held for sale.
IFRS narrowly defines what qualifies as a discontinued operation. US GAAP more broadly defines discontinued operations and could include asset groups smaller than those allowed under IFRS. US GAAP also requires that: “(a) the operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction and (b) the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.” There is no similar requirement in IFRS.
Both US GAAP and IFRS require the results of discontinued operations be shown separately from continuing operations on the income statement. The amount is reported “net of tax.” Discontinued Operations are reported after “Income from continuing operations.”
Example
Alpha Corporation had after tax income from continuing operations of $55,000,000 for the year. During the year, it disposed of its division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 for the year. Assume a tax rate of 30%. The partial income statement of the company will look as follows:
Extraordinary Items
These are nonrecurring material items that differ significantly from a company’s typical business activities. Extraordinary Item must be both of an 1) unusual nature and 2) occur infrequently
Under US GAAP, the extraordinary items are reported “net of tax” after “Income from continuing operations.”
Under IFRS, the extraordinary items are now allowed to be separated from operating results in the income statement.
Example of Extraordinary Item
An earthquake destroys one of the oil refineries owned by a large multi-national oil company. Earthquakes are rare in this geographical location. This will be considered an extraordinary item.
Unusual Gains and Losses
Material items that are unusual or infrequent, but not both, should be reported in a separate section just above “Income from continuing operations before income taxes.”
Examples can include:
- Write-downs of inventories
- Foreign exchange transaction gains and losses
These items are reported before tax. Net-of-tax treatment for these items is prohibited.
Changes in Accounting Standards
Accounting changes can include:
- Change in an Accounting Principle. This type of change occurs when a company adopts a GAAP different from the one used previously for reporting purposes. For example, change from FIFO to average cost, or change from the percentage-of-completion to the completed-contract method.
- Change in an Accounting Estimate. This type of change is required because an earlier estimate has proven to require modifying as new events occur, more experience is acquired, or additional information is obtained. For example, useful lives and salvage values of depreciable assets or allowance for uncollectible receivables.
- Prior-period Adjustment. This refers to change from incorrect accounting method to the correct accounting method, or the correction of an accounting error made previously.
A change in an accounting principle is accounted for by the retrospective application of the new accounting principle. This refers to restating the financial statements of prior periods to reflect the change.
A change in an accounting estimate is accounted for prospectively. The restatement of prior financial statements is not required.
A company accounts for the correction of a material error of a past period that it discovers in the current period as a prior period adjustment.