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Extraordinary gain is recorded as one of two extraordinary items on a company’s income statement, with the other item being extraordinary loses. An extraordinary gain refers to an unusual profit the company has made in the preceding year, which does not usually occur and is not expected to occur again in the future. All extraordinary items are recorded on the income statement and balance sheet separately from all other sources of income to better help investors understand the organization’s usual profits and losses. For example, if a company sells an asset for significantly more than its value, this might be considered an extraordinary gain because usually, the asset would only sell at its current value and would seldom sell at such inflated value. Given the fact that such gains are normally nonrecurring, companies are required to record them separately for transparency purposes.
Aside from recording extraordinary gains separately on the income and balance sheet, accountants will usually attach a note to the financial statement explaining the gains in detail. Investors as well as the Securities and Exchange Commission (SEC) for public corporations need to understand how the gains were derived in order to make sure they understand the circumstances of the company’s financial standing. If a company fails to record these gains separately and explain them adequately, such actions may skew the financial standing of the firm. With public corporations, this may also result in the SEC taking action against the company for failing to report earnings accurately and with transparency. Additionally, it is crucial to note there are two key terms used in establishing the criteria for an extraordinary item: unusual and infrequent.
Under certain circumstances, extraordinary gains may point to potential fraudulent accounting practices. Cases involving firms that consistently report a high amount of extraordinary gains or losses are usually suspect. When discontinuity turn into continuous reporting — as consistently selling assets far beyond their value that normally do not sell for that rate — it might indicate a company is trying to hide its true source of income related to the transactions. In addition, the same applies to extraordinary losses, when a firm might attempt to write off many small losses as one extraordinary loss, thereby downplaying the company’s sinking financial situation. While sometimes this might be considered a legitimate accounting practice, if done so regularly it might point to fraudulent reporting.
Just as important, understanding what does not qualify as an extraordinary gain will help investors better understand what is recorded on a balance sheet or income statement. Terms such as "unusual" and "infrequent" are strictly interpreted. Due to market dynamics, for example, some assets may very well sell beyond their recorded value on a regular basis. When such a sale takes place, it might not be considered an extraordinary gain because of the market dynamics. Instead, it is recorded with ordinary income, but often on a separate line.
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