Question

Write down ,in your own word, some examples of transitory items that affect the income statement and we ca consider them crucial .

Answer 1

There are four types of transitory Items that are consider to be crucial, They are –

1. Unusual Items
2. Extraordinary Items
3. Discontinued Operations
4. Changes in Accounting Principles

We will discuss each item type in detail.

1– Unusual Items

The first type of transitory item is Unusual Items. These items are unusual. These items are reported pre-tax whereas the other three types are reported post-tax.

Infrequent or Unusual Items Examples

• Write-offs or Write Downs of inventory or receivables
• Restructuring cost when acquiring & integrating a new company or implementing changes with in an existing one
• Gain or losses from the sale of assets in subsidiaries/affiliates
• Losses incurred from a lawsuit
• The loss incurred from a plant shutdown

2 – Extraordinary Items

The second type of transitory item is Extraordinary Items.

Extra-ordinary Items are both infrequent & unusual and are reported net of income tax.

Extraordinary Items Examples

• Compensation from the expropriation of the company’s property
• Uninsured losses incurred by the company as a result of natural calamities like earthquake, floods or Tornadoes
• Weather-related damage to a property at a place where the occurrence of weather phenomenon is less frequent
• Damage caused due to fire in a plant
• Gain or loss from early retirement of debt
• Gain on life insurance/ loss incurred on casualty
• Write-off of intangible assets

3 – Discontinued Operations

The third type of transitory item is the Discontinued Operations. These transitory items are required to be reported in the financial statements if the operation of a part of a firm is either being held for sale or has been already disposed-off. For an item to be qualified as a part of discontinued operations, two basic conditions should be fulfilled -:

1. There is no involvement/ influence by the parent company related to financial/ operational matters with in the discontinued component, once the component has been successfully disposed of.
2. The operations and cash flow from the disposed component will be eliminated from the parent’s operations.

4 – Changes in Accounting Principles

The fourth transiory item is the changes in Accounting Principles.

Changes in accounting principles happen when there is more than one principle available for applying to a particular financial situation. Changes should be backed by a rationale that proves their relevance. These changes have an impact not only on the current year financial statements but also adjust prior periods financial statements as they have to be applied retrospectively to ensure uniformity. The retrospective implementation ensures that proper comparison can be done between the financial statements of different periods. Usually, an offsetting amount is adjusted to capture the cumulative effect of such changes.

Changes in Accounting Principles Examples

• Change in inventory management principle from LIFO to FIFO or Specific identification method of inventory valuation or vice versa leads to a significant change in the inventory cost
• Change in the depreciation method from Straight line method to Sum of digits or hours of service method also leads to a significant change in the way depreciation amount is reported.