How to Define Extraordinary Items
In order to understand closing entries in accounting for extraordinary items, it is first necessary to understand why income or expenses should be categorized as extraordinary items. Extraordinary items are income and expenses that arise from events that are distinct from the ordinary activities of the enterprise and are not likely to recur frequently in future accounting periods.
Traditionally it was necessary to show such items separately from other items in the accounts. The logic behind this treatment of extraordinary items is in the interests of consistency of presentation in the accounts from one period to another to show the users of the accounts certain income or expenses were a once-time occurrence and are unlikely to occur in the future. Users of financial statements should be aware they should pay less attention to these items when considering the ongoing financial situation of the enterprise and its likely future prospects.
Examples of extraordinary items might include a natural disaster, a factory fire or expropriation of the assets of a branch of the company by a foreign government. There could also be extraordinary items relating to unusually high income, such as a large receipt from an insurance policy. Extraordinary items could also involve unusually high expenses resulting from irregular lawsuits or industrial action by employees. The unusual nature and the infrequent occurrence are the main distinguishing features of an extraordinary item.
The treatment of extraordinary items has been the subject of considerable discussion because problems arise in identification of extraordinary items and because many people consider there is no need for such items in basic accounts. Many accounting standards now prohibit or recommend against the inclusion of income or expenses as extraordinary items because they often confuse the position for the users of financial statements.
In any discussion of accounting, it is necessary to go back to basics and consider why items are categorized in a particular way. The presentation of items in financial statements is for the benefit of the users of the figures who wish to see the financial information presented in the most useful and accurate way. The users of the accounts include potential investors in the enterprise, employees, current shareholders, trade creditors and loan creditors. These stakeholders in the enterprise want to receive accounting information in a form that helps them draw accurate conclusions about the financial state of the business without being misled about past or future financial events. They want the information to be presented to them in a way that helps them to compare the past and present financial results and draw conclusions about the future by discerning trends from the accounting information. This objective should be considered when determining extraordinary items and the correct journal entries.