You own a successful dry cleaning business. Out of the blue, a tornado sweeps away your storefront and shuts you down for a few months. Your insurance will pay to rebuild but it will take time and there are other costs involved. Is the tornado expense a regular, expected occurance? Does it really hurt the value of your business? Of course not.
In the unpredictable world of business, events will arise that are not expected and most likely not occur again. These one-time events are separated on the income statement and classified as either non-recurring or extraordinary. There is a difference between the two, which I'll explain in a moment.
These two categories allow investors to more accurately predict future earnings. If, for instance, you were considering purchasing a gas station, you would base your valuation on the earning power of the business, ignoring one-time costs such as replacing the station's windows after a thunderstorm. Likewise, if the owner of the station had sold a vintage Coke machine for $17,000 the year before, you would not include it in your valuation because you had no reason to expect that profit would be realized again in the future.
The Difference Between Non-Recurring and Extraordinary Events on the Income Statement
What is the difference between non-recurring and extraordinary events?
- Non-Recurring Event: A non-recurring eventis a one-time charge that the company doesn't expect to encounter again. An extraordinary item is an event that materially* affected a company's finance and needs to be thoroughly explained in the annual report or SEC filings.
- Extraordinary Event: Extraordinary events can include costs associated with a merger, or the expense of implementing a new production system (as McDonald's did in the late 1990's with the Made for You food preparation system).
There is an important distinction between the two categories: Non-recurring items are recorded under operating expenses, while extraordinary items are listed after the net line, after-tax.
* The term material is not specific. It generally refers to anything that affects a company in a meaningful and significant way. Some investors try to put a number on the figure, saying an event is material if it causes a change of 5% or more in the company's finances.
This page is part of Investing Lesson 4 - How to Read an Income Statement. To go back to the beginning, see the Table of Contents.