Non-Recurring Item

Author:

Reviewed By:

Last Updated:January 7, 2024

In This Article

What is a Non-Recurring Item?

Non-recurring items are entries that appear in the business’s accounting books and are unlikely to happen again because it is too uncommon and not usual for the company. This can stem from infrequent gains or losses, depending on what is reported.

There are generally four main types of non-recurring items, namely:

Infrequent/unusual items
Extraordinary items
Discontinued operations
Changes in accounting

These gains/losses will be reported in the income statement and must be “scrubbed” away to normalize the business to only its ongoing operating performance.

Since these items only occur once and stem from extraordinary events, they are unlikely to factor into the company's long-term profitability.

Further, non-recurring items are the opposite of recurring items. Recurring items are defined as income and expenses gained/lost due to the specific line on the financial statement being likely to continue.

Most significant non-recurring items are reported and found on the income statement.

Although non-recurring items might sometimes be single-line items, some occurrences see non-recurring items as separate, embedded items with other items on the same line.

For instance, reading the Management, Discussion, and Analysis (MD&A) could help identify non-recurring items hidden in the income statement.

MD&A are sections within a company’s report/filing that analyze the company’s performance at the end of business management, along with financial results, risk, and prospects.

Moreover, footnotes should also be carefully examined to extract the necessary non-recurring items from the line in the financial statement.

Key Takeaways

Non-recurring items are uncommon events in a company's accounting books that are unlikely to happen again.
Four main types of non-recurring items: Infrequent/unusual items, extraordinary items, discontinued operations, and changes in accounting principles.
Non-recurring items must be scrubbed to reveal the actual operating performance of the company.
Industry knowledge is vital to differentiate what qualifies as non-recurring in specific sectors.
Infrequent/unusual items are pre-tax and reported above the gross profit line, e.g., gains/losses from asset sales and restructuring costs.
Accurate scrubbing of non-recurring items ensures a more precise assessment of a company's financial health for investors and stakeholders.

Unveiling Non-Recurring Items in Financial Reporting

The item must be identified from the myriad entries in the accounting. Many items might be embedded within other lines of items and sometimes are combined with other recurring items.

To extract this information and be able to judge which numbers are best used is a challenge.

Several keywords that one can look for while “scrubbing” involve words like:

Infrequent/ Unusual
Extraordinary
Non-recurring

Items such as “extraordinary dividend” payouts should be considered in this category, and other similar lines should as well.

In the realm of financial reporting, understanding non-recurring items requires sifting through extensive data. This entails examining balance sheets, income statements, and cash flow statements.

Additional materials, like earnings releases, can offer insights, though discerning their relevance demands careful consideration. Industries vary in their treatment of non-recurring items.

For instance, research and development (R&D) costs might be operational for some but exceptional for others, such as STEM companies.

This exploration delves into these intricacies, highlighting the industry-driven nuances in grasping and evaluating non-recurring items.

1. A vast swath of data

When ascertaining what constitutes “non-recurring,” businesses should note that they have much data to comb through.

In financial reporting, one has to look through the balance sheet, income statement, and cash flow statement separately to calculate correctly.

Further from just company supplementals, further information might be helpful or not, depending on the beholder. This requires a value judgment to decide its utility to the investor.

This includes earnings press releases or shareholder presentations. Often, these items are unlikely to help in the correction of the draft non-recurring item's value.

However, they should nonetheless be read in case a non-recurring item is hidden in the statements made.

2. Industry knowledge

Specific industries may have more liberal/conservative thinking methods; therefore, what classifies as a non-recurring item also differs based on them.

Litigation fees are a non-recurring expense for a STEM company, but items such as R&D might be seen as operational expenses. They might be calculated despite not being a traditional cost of business in other industries.

STEM companies rely on experimentation to create new goods and services for the public, more so than traditional industries. For instance, Pfizer would not count R&D expenses in their non-recurring items.

Hence while R&D is “scrubbed” from other industries, its inclusion in calculating items such as DCF for STEM-reliant pharmaceutical companies should be noted.

Infrequent/ Unusual items

These items are referred to as either infrequent or unusual, but not both simultaneously. They hold the characteristic of being pre-tax, which implies that they are excluded from future earnings when conducting forecasts.

Furthermore, these items are classified “below the line," with the line representing gross profits. Accordingly, these items find their accounting under other income/expenses.

The process involves diligently reviewing footnotes and any Management Discussion and Analysis (MD&A) reports to identify and compute these non-recurring items, mainly when calculating metrics like EBIT/EBITDA for personal financial analysis.

These items include:

Gains/losses from the sale of company assets or business segments
Gains/losses from asset impairments, write-offs, or
Restructuring costs when integrating a new company or implementing changes in existing divisions
Losses from lawsuits
Provision for environmental remediation

In this category, gains and losses arising from selling company assets or business segments are incorporated.

Additionally, gains or losses resulting from asset impairments, write-offs, and restructuring costs while integrating a new company or implementing changes in existing divisions qualify as such items.

Furthermore, losses stemming from lawsuits and provisions for environmental remediation are included.

The consideration of whether these events are genuinely infrequent or mainly unusual depends on the industry in which the company operates.

For instance, catastrophe losses may not be considered unusual or infrequent for property or insurance companies, as dealing with and insuring against such risks is inherent to their trade.

However, an oil production company might perceive these losses as infrequent if one of its factories is situated within the impact zone of the catastrophe. The company would appropriately classify it as a one-time non-recurring item in this case.

For instance, Exxon would classify a hypothetical earthquake hitting and disrupting one of its oil-producing areas as a non-recurring item. However, companies such as Geico would have to classify it as just an ordinary expense for their business.

Extraordinary items

Items that are both infrequent and uncommon are classified as extraordinary items. Unlike the above, these are tax-affected (net of income tax) and hence will show “under the line.”

When these extraordinary items are shown “below the line” in the income statement, they will be under the gross profit line. They are shown after the “income from continuing operations" line item.

These items should also have a significant, material impact on the company’s day-to-day operations. This means that these are grouped along with Sales General and administrative costs and are one of the components deducted from gross profits to calculate net profits.

For instance, in specific industries, natural disasters such as an earthquake or tsunamis are classified as uncommon and infrequent, destroying uninsured company property. Hence, they will be classified as extraordinary items.

Take note that while this is accepted under GAAP (General Accepted Accounting Principles), it is not accepted under IFRS (Internal Financial Reporting Standards).

Note

Detailed explanations of these extraordinary items must be included in footnotes as per the SEC’s (Securities and Exchange Commission) requirements. This will be seen as a one-time expense following an unpredictable event.

Other types of extraordinary items include:

Compensation from the expiration of the company’s property
Write-off of intangible assets
Gain/loss from early retirement of debt
Gain on life insurance
Loss incurred due to casualty

Discontinued operations

Discontinued operations are defined as the disposal of a specific company segment or division that is distinct from the company’s operations (the remaining businesses that operate under the cooperation).

This disposal could come through either a divestiture (where the cooperation proceeds with either a partial or outright sale of the division it once owned), or the division is rendered redundant and removed.

Discontinued operations are also “under the line” and likewise are tax affected (net of income tax). They are separately shown after the “income from continuing operations" line item.

Discontinued operations are divisions that are being disposed of and contributed once to the recurring net income of the company (after the disposal, it is no longer contributory).

For discontinued operations, there must be no involvement with the parent company any longer. This includes influence in the financial and operational matters of the discontinued component.

Likewise, operations and the cash flow generated by the disposed division are now distinct and no longer linked to the parent company’s operations.

Note

If the business is considered “discontinued operations”, it counts as contingent liabilities.

A contingent liability is a potential obligation that arises from past events but depends on uncertain future events for its existence.

These liabilities are not certain to occur and may only become actual liabilities if certain conditions are met. Contingent liabilities are disclosed in the notes to the financial statements, but they are not typically recorded on the balance sheet until they become actual liabilities.

A company may classify the adjustments separately in the discontinued operations section of its financials

Interest expense (if the buyer assumes any debt with association to the sold product), adjustments to the related selling price (changes or adjustments to the agreed upon selling price), and employee benefit plans of the disposed division are also included in this line.

Changes in Accounting Principles due to Non-recurring Items

At times, the method by which companies evaluate their accounting policies might change depending on the principles available and might switch based on the accounting situation open to the business.

That said, changes in accounting principles must be substantiated and relevant to the situation.

Note

When a company changes its accounting principles, the period before the current accounting period also has to be changed to reflect the uniformity of accounting methods.

Hence, changing the accounting principles requires a great undertaking by the company in and of itself.

When there are changes in accounting principles, the company's public filings must reflect this change and incorporate management commentary; the precise reason for the change and the nature of the change must be reflected in writing.

An example of such a change is a move from First in, first out (FIFO) to Last in, first out (LIFO).

FIFO means that inventory purchased earlier is to be first recognized and reflected on the income statement (under COGS). LIFO means that the more recently created goods ahead of those made earlier are sold first.

Assume a company uses LIFO to reflect the volatile prices or inflation more appropriately, lower the cost of new inventory, and lower tax liabilities when prices rise (as COGS increase with LIFO and hence lower tax margin is imposed).

However, if the company wants to move internationally from the US, where IFRS (International Financial Reporting Standards) does not want to present two different fillings for a global investor and a local investor, they could move from LIFO to FIFO.

This could save costs, as creating two different statements would require a more excellent accounting backbone and dollars for requiring more from the accounting team.

Like most other non-recurring items, this will be tax-affected (net of income tax). These are “under the line” items.

Some other instances where a change in accounting policies may apply are in depreciation policy (Useful life assumption of fixed asset, salvage value) or correction of mistakes in past filings.

Conclusion

In conclusion, recognizing and adequately handling non-recurring items in financial statements is paramount for investors, analysts, and stakeholders to accurately understand a company's ongoing performance and long-term prospects.

These exceptional items, including infrequent/unusual events, extraordinary occurrences, discontinued operations, and changes in accounting principles, can significantly impact reported earnings.

To "scrub" these non-recurring items effectively, one must carefully comb through financial statements, footnotes, and supplementary reports. Keywords like "unusual" and "infrequent" are valuable indicators for identifying such items.

Moreover, industry-specific knowledge is vital to distinguish events that may be routine in one sector but extraordinary in another.

While scrubbing non-recurring items may present challenges, such as identifying embedded objects or deciphering complex accounting changes, the effort is crucial to better understanding a company's operational performance.

By eliminating these one-time events, analysts can better forecast future earnings and assess the company's sustainable profitability.

Ultimately, by discerning and appropriately accounting for non-recurring items, investors can make more informed decisions, and companies can communicate their ongoing financial health more transparently.

Financial reporting standards can also promote greater clarity and accuracy in corporate disclosure. As a result, they are leading to the betterment of investor transparency and investor confidence.