An Explanation of Extraordinary Items for Depreciation Expense With Examples

An Explanation of Extraordinary Items for Depreciation Expense With Examples
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Depreciation and Extra Ordinary Items

Depreciation is the portion of the tangible capital asset deemed consumed or expired. The standard accounting practice is to spread such depreciation over several years, based on the generally accepted accounting standards. For instance, in straight-line deprecation, the cost of the asset divides equally over the expected life of the product. The Modified Accelerated Cost Recovery System (MACRS) (the prevalent depreciation system stipulated by the IRS), uses annual deduction of the value of assets based on detailed tables published by the IRS that denotes lives by classes of assets.

Extraordinary items require special reporting in the balance sheet – reporting abnormal or unusual transactions that do not occur frequently and are unlikely to recur. Such items are included in the income statement in a separate section.

Extraordinary items can include losses related to an unexpected natural disaster, expropriation, prohibitions under new regulations and so on. A single item can find inclusion as both an extraordinary item and a standard item, depending on the nature of the business.

For instance, an agricultural company in Canada losing plants owing to frostbite, cannot claim the same as an extraordinary item, as frost is a regular occurrence in Canada. A company in New Mexico can, however, claim crop loss owing to frostbite as an extraordinary item, as frostbite is a highly unlikely occurrence in the tropics and unlikely to recur in the foreseeable future. Similarly, some instances such as normal disposal of company assets, as part of renovation or overhaul, do not constitute an extraordinary item, but loss of machinery owing to lightning strike may constitute an extraordinary item.

Accounting standards do not allow including regular and normal depreciation expenses as an extraordinary item.

Extraordinary Items and Depreciation Expense

Including extraordinary items for depreciation expense depends on the life of the asset when the extraordinary transaction occurs.

For instance, a vehicle worth $100,000 with a depreciation period of ten years, may become worthless owing to an accident after 12 years of use, and receive a mere $500 as scrap sale. In such case, the net value of the vehicle is already present in the accumulated depreciation. The $500 records as cash inflow, and both the accumulated depreciation, and the value of the vehicle, offsets itself in the balance sheet.

Now assume the same vehicle become worthless owing to a major accident after one year of purchase, leading to an actual salvage value of $500. In this instance, the accumulated depreciation does not cover the value of the car, and the income statement shows a loss under extraordinary items. The value of the extraordinary item is the total recorded value of the vehicle, less any accumulated depreciation, and the salvage value realized. Assume the depreciation for the first year was $10,000. The loss for the extraordinary item is $100000 - $10000 - $500 = $89,500.

To account for extraordinary items subject to depreciation:

  1. Debit accumulated depreciation account
  2. Credit fixed asset account
  3. Debit loss of the disposal of fixed assets

The inclusion of extraordinary items is subjective and very often open to debate. The soundness of the inclusion depends on professional judgment, and inclusion invariably requires adding supplementary notes to the financial statement to explain the nature of such extraordinary items.

Reference

Nikolai, Loren, A.; Bazley, John, D. & Jones, Jefferson, P. (2009). “Intermediate Accounting.” Cengage Learning.

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