Simply Put: Extraordinary & Exceptional items

Yash and Chaitanya were discussing the results season when the following conversation unfolded:

Yash: I look forward to quarterly results of companies but the moment I see ‘extraordinary or exceptional items’ I get confused.

Chaitanya: Understanding extraordinary and exceptional items is necessary to comprehend the real state of a company’s business These items may make an operationally sound business look poor — and vice-versa.

Yash: How are these items shown in the financial statements?

Chaitanya: According to Indian Accounting Standards (AS 5), extraordinary and exceptional items are to be shown separately since these events are not expected to recur frequently.

Yash: I get it. What are extraordinary and exceptional items exactly?

Chaitanya: Ok. let me explain. Extraordinary items consists of gains or losses from transactions that are not in the usual course of business and are infrequent. The most common are prior period items — such as adjusting previous period income taxes or adjusting retained earnings reserves. Another extraordinary item may be the gain or loss on sale of company assets such as land or buildings.

On the other hand, exceptional items are unusual and infrequent transactions but are related to the regular business of the company. The common examples of exceptional items are losses from natural calamity/disaster such as cyclone, earthquakes, riots, etc. They also include write-offs of intangible assets such as goodwill, trademarks, unamortised bond premiums, etc.

Yash: I am still unable to understand how this is relevant while analysing a business.

Chaitanya: Extraordinary and exceptional items are significant in that they can have impact on the net profit of a company. Since these items are infrequent in nature and do not necessarily recur every quarter, factoring them in may give a distorted picture of the business.

Here’s an illustration: In FY23, KNR Constructions divested its stake in its three subsidiaries and realised a profit of ₹138 crore.

It is common for Infrastructure companies to sell stake in certain projects after completion whose revenues are staggered in future by way of toll or annuity. Therefore, the company classified this transaction as exceptional item as this transaction is part of business but not a frequent one.  The profit before tax (PBT) of the company before considering this profit was ₹567 crore. The final PBT was reported as ₹705 crore, which is 24 per cent higher owing to this exceptional item.

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