Exceptional Item

Exceptional Item
See also
Extraordinary Item Accounting concepts Unexpired risk reserve Sundry income Materiality principle Fictitious asset Book profit Common-size financial statement Held to maturity securities Open item

An exceptional item is an accrued transaction fee that should be recorded on the company's balance sheet in accordance with GAAP principles. These are significant items that come from events or transactions that fall within the scope of the ordinary activities of the reporting entity. If the financial statement is to give a true or fair view, exceptional items must be disclosed due to their size or frequency. Exceptional items arise in the ordinary course of business and it must be material.

Categories of exceptional item

There are considered to be two categories of exceptional items:

• those that must be shown in the income statement after operating profit and before interest,
• other items that should be attributed or charged to profit or loss on ordinary activities by taking into account statutory items to which they relate and which must be disclosed separately in the form of a note or, in the risk and loss account.

The appearance of the first category of exceptional item is clearly defined. If one of the items listed in the relevant paragraph appears, it should be shown separately in the income statement. To make it easier, we refer to this category as non-operating exceptional items.

However, when it comes to the second category of exceptional items, assigning items to the appropriate statutory headers will in most cases be simple. There are sometimes exceptions when the directors of a reporting entity reach that exceptional items are not explicitly included in the headings of a particular format. It may be necessary to add a new line item in the profit and loss account to include the exceptional item. This can occur if the item does not refer to any particular item in the statutory format. The exact position in the income statement depends on the directors' view of what they think is the most appropriate. The definition of operating profit by directors determines whether items appear before or after the operating profit line, because this term is not formally defined and is not used in statutory formats.

Examples of exceptional items

“Examples of exceptional items are:

• Profits or losses on the sale or termination of an operation.
• Cost of a fundamental reorganisation or restructuring having a material effect on the nature and focus of the reporting entity's operations.
• Profits or losses on disposal of fixed assets.”

“In some sectors, exceptional items are an intrinsic part of the business. A car rental company renews its fleet of cars every nine months and regularly registers capital gains. Exceptional items should then be analysed as recurrent items and as such be included in the operating profit. For smaller companies, exceptional items tend to be one-off items and as such should be seen as non-recurring items. It makes no sense to assess the current level of non-recurring items from the perspective of the company's profitability or to predict their future trends. Analysts should limit themselves to understanding their origin and why, for example, the company needed to write down the goodwill.”

Advantages of Exceptional Item

An exceptional item is an important part of the financial statements that helps to provide a better view of the company's performance. It is beneficial for the company because it reflects the true financial position of the company and helps to provide a more accurate picture of the business. The advantages of including exceptional items are:

• Improved financial reporting accuracy: Exceptional items help provide a more comprehensive picture of the company's performance by capturing non-recurring and infrequent activities. This allows investors, creditors, and other stakeholders to better assess the financial position of the company.
• Improved performance analysis: Exceptional items provide insight into the performance of the company over the long-term, rather than just the short-term. This helps to provide a better understanding of the company's overall financial performance.
• Improved decision-making: Exceptional items help to identify areas of improvement and can be used to inform strategic decision-making. This enables the company to identify areas of opportunity and make more informed decisions.

Limitations of Exceptional Item

The limitations of exceptional items include:

• The items must be material to the financial statement in order to be considered exceptional.
• Exceptional items must be disclosed on the balance sheet with a clear explanation of the nature of the item and its impact on the financial statement.
• Exceptional items should be categorized and grouped separately from other items on the balance sheet.
• The exceptional items must arise from events or transactions that are within the scope of the ordinary activities of the reporting entity.
• The items must be significant in size and frequency to be considered exceptional.
• Exceptional items should be reviewed periodically to ensure that they are still relevant and necessary.

Other approaches related to Exceptional Item

• The other approaches related to exceptional items are:
• Recognition and measurement of exceptional items, which involves determining the nature, cause, and amount of each exceptional item. This includes consideration of the time period in which the item occurred and whether it is nonrecurring in nature.
• Disclosure of exceptional items, which involves disclosing the amount and type of each exceptional item. This includes providing details of the nature and cause of each item, and the amount of each item in isolation or as a group.
• Identification of exceptional items, which involves considering whether an item is considered to be an exceptional item and therefore should be reported separately.
• Analysis of exceptional items, which involves analyzing the effects of the exceptional items on the financial statements, including the impact on income, cash flow and balance sheet accounts.

In summary, exceptional items must be recognized, measured, disclosed, identified and analyzed in order to present a true and fair view of the company’s financial statements.

References

• Davies M., Paterson R., Wilson A. (1997), UK GAAP: Generally Accepted Accounting Practice in the UK, Springer, Ernst & Young, UK
• Gupta A. (2008), Financial Accounting for Management: An Analytical Perspective, Pearson Education India
• Hanif M., Mukherjee A. (2018), Modern Accountancy (Volume II), 3e, McGraw-Hill Education (India)
• Vernimmen P., Quiry P., Dallocchio M., Yann Le Fur, Salvi A. (2014), Corporate Finance: Theory and Practice, John Wiley & Sons, Ltd.

Author: Monika Wójcik