Financial statement users hope that historical performance reflected on income statements might provide some meaningful grounds for predicting a company’s future performance. In the case of well established businesses operating in stable
environments this would be a reasonable expectation. It’s too bad that in the real world there are so few businesses like this. Nonetheless, hope (or wishful thinking) springs eternal. For this reason GAAP rule makers allow management to distinguish between ordinary versus extraordinary gains and losses reported on income statements. The idea behind separating the extraordinary from ordinary results is that such a separation will give statement users a more realistic picture of operating results going forward.
There are two criteria for reporting extraordinary losses or gains. The events driving the gains and losses must be unusual and non-recurring. Actually almost always the concern is with extraordinary losses rather than gains. This is because managers are usually quite content to consider almost all gains as ordinary and most losses as extraordinary.
Losses incurred by timber companies due to the eruption of Mount St Helens were deemed to be extraordinary. However, GAAP rule makers deemed losses from the 9/11/01 attack on the World Trade Center not to be extraordinary. How the former event could be considered unusual and non-recurring while the latter was not is very hard to understand.
One text book commented that GAAP rule makers were reluctant to characterize the losses stemming from 9/11 as extraordinary because they feared managers would allocate losses not related to the attack. Of course the same thing could have happened in the case of the Mount St. Helens eruption as well.
From the above example you might infer that it would be hard for management to show any gains or losses separate from those deemed to be ordinary. Think again. GAAP allows management to show separately the results of events that are unusual or non-recurring but not both. As you can imagine this opens the door to all kinds of mischievous allocations and disclosures.
The most mischievous separate disclosures involve what are euphemistically called “Corporate Restructurings”. Like most euphemisms this term puts a sanitary gloss on some really ugly messes. Restructurings usually involve plant closings and relocations, widespread employee layoffs and other unpleasantness. But more to the point they also usually involve big losses And of course corporations are always restructuring. So it is very common to see a corporation’s income statement have a separate line labeled “Restructuring Charge”. And usually to the immediate right is a very large bracketed number.
Example. Having experienced declining market share and profits Mizer Pharmaceuticals lays off 30% of its staff, closes research facilities, relocates manufacturing facilities to Somalia and doubles the salary of the CEO. Losses are in the 100s of millions. Instead of showing the losses as ordinary they are classified as a Restructuring Charge. A more accurate label for these “Restructuring Charges” might be something like “Losses due to Mismanagement”.
Probably not. Nonetheless allowing income statements to include large losses labeled as restructuring charges cannot enhance financial statement user’s confidence in the quality of the accounting information they are getting.
By the author of the acclaimed book Financial Accounting: A Mercifully Brief Introduction. To get your copy for only $9.95 + $2 shipping click here.