Have you ever compared a company’s financial statements from different periods closely? If you have, you would know how some items like exceptional items can create a variance on the final balances. As a stakeholder, financial results can be misleading to you if you do not understand the effects of such exceptional items.
To make it easier for you, we have explained everything about exceptional items in this blog.
What are Exceptional Items?
There are some items in a company’s financial statements that can lead to unusual profits and losses in the final balance of a company. If such items are related to the operations of a company, then they fall under exceptional items.
Companies mention these items separately in financial statements because they can result in significant deviation in the results of an entity. As the name suggests, these items do not occur on a regular basis.
Some Examples of Exceptional Items
As mentioned above, exceptional items are related to the regular operations of a company. The Ministry of Corporate Affairs has laid out Accounting Standards (AS) which are to be followed by all the qualifying financial entities while maintaining accounts.
As per the ,AS document,some examples of exceptional items include:
- Disposal of items of fixed assets
- Disposal of long-term investments
- Legislative changes having retrospective applications
- Litigation settlements
Features of Exceptional Items
- Rare occurrence: Exceptional items, even though are related to operations of a company, do not occur on a regular basis. The incidence of this happening is rare. As in the above-mentioned example, a company does not sell its machinery every day; hence, it is of rare occurrence.
- High in value: Exceptional items usually carry a high value. So, if it is a large expense, it will obviously bring down profits of the company by a huge margin and vice versa if it is an income. Thus, due to their value, they become an item of significance.
- Related to operations of the company: All items of exceptional nature must be related to the operations of that company in some way. If the items have no connection with the operations, then they are not exceptional items.
- Separate mention in the notes: All exceptional items need to be explained individually with their material information. Companies mandatorily give this information as notes in the financial statements of the company. The reason behind this is to explain the effects of such items on the final figures.
Because of their high value and rare occurrence, a lack of notes can mislead the person analysing the financial statements.
How Are Exceptional Items Different from Extraordinary Items?
Both exceptional and extraordinary items seem quite similar on the surface. However, they are not the same.
One major differentiating factor between extraordinary items and exceptional items lies in their relation to the operations of the company. Exceptional items arise out of the operations of the company, but not extraordinary items. Extraordinary items, on the other hand, are rarely occurring items that are not related to the operations of the company.
Continuing with the above example of writing off machinery, if a company sells its machinery, it will be categorized as an exceptional item. However, if the same machinery gets damaged due to a flood and the company writes it off, it will be mentioned under extraordinary items. Since the occurrence of flood is not regular and is not related to the operations of the company, such a write-off will be classified as an extraordinary item.
Irrespective of the examples given above, companies must keep in mind the nature of the business it conducts to decide whether they can write something off as an exceptional item. Just because selling machinery here is given as an example of an exceptional item, it does not stand the same for every company.
A company that is in the business of manufacturing and selling machinery will mention such transactions as part of its operations. But for a company that sold a piece of machinery that it used for manufacturing other products, it would be an item of exceptional nature.
Frequently Asked Questions
Why should investors know the exceptional items of a company?
Exceptional items of a company can show an unusually high profit or loss for the company during a particular period. However, since they are not of ordinary nature, they might not happen again anytime soon. Investors should analyse and check whether the exceptional items are truly exceptional in nature.
A company sold a machine at a profit of just ₹10,000. Will it be written as an exceptional item?
For an item to be considered exceptional, it must be of a significantly high value because only then would it make any influence over the decision-making of any stakeholder. Therefore, an item with a value of just ₹10,000 would generally not be an exceptional item.
Is restructuring a company an exceptional item?
The impact of restructuring can be big as it may include merging divisions and laying off staff, the effects of which can be high in monetary terms. As this is an unusual event, restructuring will be termed as exceptional items.
Why do exceptional items need separate disclosure?
Exceptional items are disclosed separately mainly to aid the understanding of financial statements. If not, a person without an in-depth understanding of financial statements might fail to notice their impact. He/she might mistakenly relate the final figures with the performance of the company, which won’t be true.