101 Concepts for the Level I Exam

Concept 44: Non-Recurring Items & Changes in Accounting Policies

Non-recurring items: A company needs to separate revenues and expenses into items that are likely to continue in the future and items that are not likely to continue in the future. This helps analysts to predict future earnings of the company. Items that are not likely to continue can be classified as:

  • Discontinued operations: An operation that the company has disposed in the current period or is planning to dispose in future. On the income statement, discontinued operations are shown as a separate line item, net of tax, after net income from continuing operations.
  • Extraordinary items: IFRS does not allow this classification. Under U.S. GAAP an item is extraordinary if it is both unusual in nature and infrequent in occurrence. For example, destruction of property in an earthquake. On the income statement, extraordinary items are shown as a separate line item, net of tax, after net income from continuing operations.
  • Unusual or infrequent items: These items are either unusual in nature or infrequent in occurrence, but not both. For example, gains or losses from selling a manufacturing equipment. On the income statement, they are shown as a separate line item, but before tax, and are included in the income from continuing operations.

Changes in accounting standards

  • Change in accounting policy: This refers to change from one accounting method to another. For example, changing inventory valuation method from LIFO to FIFO. It requires retrospective application, i.e. all prior period financial statements need to be restated as per the new method.

A retrospective application, helps maintain comparability of the statements across different time periods.

  • Changes in accounting estimate: This refers to change in the management’s estimate. For example, changing the useful life of a depreciable asset. It requires prospective application, i.e. no need to restate prior period financial statements, only statements presented going forward reflect this change.
  • Correction of prior-period error: This refers to an adjustment done to correct a prior period accounting error. All prior period statements should be restated. In addition, disclosure of the nature of the adjustment is required in footnotes. Frequent errors may point to weakness in the company’s accounting system or internal controls.