Technical Alert

In January 2015, the FASB issued ASU 2015-01, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. This ASU is part of the FASB's Simplification Initiative. The ASU eliminates from GAAP the concept of extraordinary items. The Board eliminated extraordinary items because of feedback that the criteria (unusual in nature and infrequent in occurrence) for classifying an item as extraordinary were unclear and the usefulness of the classification was questionable. The use of the classification was also extremely rare.

By moving unusual and infrequent events to the presentation and disclosure guidance for items that are unusual or infrequent, the FASB is of the opinion that the information most useful to investors and other financial statement users will be retained.

Subtopics

ASC, Income Statement, contains three subtopics:

• ASC 220-10, Overall, which provides general income statement guidance and guidance on the structure of the Topic.
• ASC 220-20, Extraordinary Items, which addresses the classification, presentation, and disclosure of extraordinary events and transactions and the presentation and disclosure of unusual and infrequently occurring items that do not meet the extraordinary criteria. (See Technical Alert above.)
• ASC 220-30, Business Interruption Insurance, which provides presentation and disclosure requirements for business interruption insurance.

The three subtopics provide discrete information and are not interrelated.

Scope and Scope Exceptions

The guidance in ASC 225 applies to all entities. ASC 225-20-15-2 specifically mandates that “The net effect of discontinuing the application of regulatory operations accounting addressed in Section 980-20-40 shall be recognized as an extraordinary item and thus shall be subject to the scope of this Subtopic regardless of whether the criteria discussed in paragraph 225-20-45-2 are met.”

Overview

The primary focus of financial reporting is to provide information about an entity's performance that is useful to present and potential investors, creditors, and others when they are making financial decisions. In financial reporting, performance is primarily measured by net income and its components, which are provided in the income statement.

In contrast to the statement of financial position, which provides information about an entity at a point in time, an income statement provides information about a period of time. It reflects information about the transactions and other events occurring within the period. Most of the weaknesses of an income statement are a result of its periodic nature. Entities are continually creating and selling goods and services, and at any single point in time some of those processes will be incomplete.

Format of Statements of Income and Comprehensive Income

The basic order of presentation of information in an income statement (or statement of income and comprehensive income) is defined by accounting standards, as shown by the diagram below. Other than in the section “income from continuing operations,” the display of revenues, expenses, gains, losses, and other comprehensive income is predetermined by the Codification guidance. Only within income from continuing operations do tradition and industry practice determine the presentation.

The three items that are shown in the heading of an income statement are

1. The name of the entity whose results of operations is being presented
2. The title of the statement
3. The period of time covered by the statement.

Income from Continuing Operations

The section “income from continuing operations” includes all revenues, expenses, gains, and losses that are not required to be reported in other sections of an income statement.

There are two generally accepted formats for the presentation of income from continuing operations: the single-step and the multiple-step formats.

In the single-step format, items are classified into two groups: revenues and expenses. The operating revenues and other revenues are itemized and summed to determine total revenues. The cost of goods sold, operating expenses, and other expenses are itemized and summed to determine total expenses. The total expenses (including income taxes) are deducted from the total revenues to arrive at income from continuing operations.

Multiple-step format. Some believe that a multiple-step format enhances the usefulness of information about an entity's performance by reporting the interrelationships of revenues and expenses, using subtotals to report significant amounts. In a multiple-step format, operating revenues and expenses are separated from nonoperating revenues and expenses to provide more information concerning the firm's primary activities. This format breaks the revenue and expense items into various intermediate income components so that important relationships can be shown and attention can be focused on significant subtotals. Some examples of common intermediate income components are as follows:

1. Gross profit (margin)—The difference between net sales and cost of goods sold.
2. Operating income—Gross profit less operating expenses.
3. Income before income taxes—Operating income plus any other revenue items and less any other expense items.

Income from Continuing Operations. The following items of revenue, expense, gains, and losses are included within income from continuing operations:

1. Sales or service revenues are charges to customers for the goods and/or services provided during the period. This section should include information about discounts, allowances, and returns in order to determine net sales or net revenues.
2. Cost of goods sold is the cost of the inventory items sold during the period. In the case of a merchandising firm, net purchases (purchases less discounts, returns, and allowances plus freight-in) are added to beginning inventory to obtain the cost of goods available-for-sale. From the cost of goods available-for-sale amount, the ending inventory is deducted to obtain the cost of goods sold.
3. Operating expenses are primary recurring costs associated with central operations (other than cost of goods sold) that are incurred in order to generate sales. Operating expenses are normally reported in the following two categories:
   1. Selling expenses
   2. General and administrative expenses.

   Selling expenses are those expenses directly related to the company's efforts to generate sales (e.g., sales salaries, commissions, advertising, delivery expenses, depreciation of store furniture and equipment, and store supplies). General and administrative expenses are expenses related to the general administration of the company's operations (e.g., officers and office salaries, office supplies, depreciation of office furniture and fixtures, telephone, postage, accounting and legal services, and business licenses and fees).

4. Gains and losses result from the peripheral transactions of the entity. If immaterial, they are usually combined and shown with the normal, recurring revenues and expenses. If they are individually material, they should be disclosed on a separate line. Examples are write-downs of inventories and receivables, effects of a strike, gains and losses on the disposal of equipment, and gains and losses from exchange or translation of foreign currencies. Holding gains on available-for-sale securities are included in other comprehensive income rather than income from continuing operations.
5. Other revenues and expenses are revenues and expenses not related to the central operations of the company (e.g., interest revenues and expenses, and dividend revenues).
6. Unusual or infrequent items should be reported as a separate component of income from continuing operations.
7. Goodwill impairment losses are presented as a separate line item in the income from continuing operations section of the income statement.
8. Exit or disposal activity costs are included in income from continuing operations before income taxes.
9. Income tax expense related to continuing operations is that portion of the total income tax expense applicable to continuing operations.

ASC 225-20, Extraordinary and Unusual Items

Unusual or Infrequent Items

Items that are unusual or infrequent, but not both, should be reported as a separate component of income from continuing operations. The EPS effect of these items should not be separated on the face of the income statement. (ASC 225-20-45-16)

Pro Forma Earnings

Companies have made reference in press releases and published materials to an alternative measure of performance, referred to as “pro forma earnings.” This practice has generated confusion because there is no standard definition for “pro forma earnings.” Different reporting entities can, and have, defined pro forma earnings on a wide range of ad hoc bases, and sometimes a given entity fails even to consistently define this amount from period to period.

Often, even when GAAP-basis earnings are stated in the same announcement as the pro forma measure, it is the latter that receives most of the attention. In a number of instances, pro forma earnings have been based on very aggressive exclusions of operating costs and, sometimes, the inclusion of onetime gains. Such practices ultimately came to be widely recognized as being misleading and inappropriate, and popular sentiment turned against employment of such devices.

The SEC adopted Regulation G to curtail the use of pro forma earnings statements. Regulation G states that a public company, or a person acting on its behalf, is not to make public a non-GAAP financial measure that, taken together with the information accompanying that measure, either contains an untrue statement of a material fact or omits a material fact that would be necessary to make the presentation of the non-GAAP financial measure not misleading. Further, Regulation G requires a public company that discloses or releases a non-GAAP financial measure to include in that disclosure or release a presentation of the most directly comparable GAAP financial measure and a reconciliation of the disclosed non-GAAP measure to that directly comparable GAAP financial measure.

The regulations also prohibit certain non-GAAP measures from inclusion in SEC filings. Public companies must not:

1. Exclude from non-GAAP liquidity measures charges or liabilities that required, or will require, cash settlement, or would have required cash settlement absent an ability to settle in another manner. However, earnings before interest and taxes (EBIT) and earnings before interest, taxes, depreciation, and amortization (EBITDA) are permissible.
2. Create a non-GAAP performance measure that eliminates items identified as nonrecurring, infrequent, or unusual if the nature of the excluded item is such that it is (a) reasonably likely to recur within two years or (b) similar to a charge or gain that occurred within the prior two years.
3. Present non-GAAP financial measures on the face of the registrant's financial statements prepared in accordance with GAAP or in the accompanying notes.
4. Present non-GAAP financial measures on the face of any pro forma financial information required to be disclosed by Article 11 of Regulation S-X (e.g., business combinations or disposals).
5. Use titles or descriptions of non-GAAP financial measures that are the same as, or confusingly similar to, titles or descriptions used for GAAP measures.

ASC 225-30, Business Interruption Insurance

ASC 225-30 provides guidance on presentation and disclosure of business interruption insurance. This type of insurance may cover:

• Gross margin lost because of the suspension of normal operations,
• Fixed charges,
• Expenses related to gross margin, and
• Expenses incurred to reduce the loss from business interruption, etc.

Entities may choose how to record proceeds from business interruption insurance as long as it does not conflict with other standards. Disclosure requirements can be found in the Appendix.