SUBJECT: PROPER REPORTING OF EARTHQUAKE DAMAGE COSTS On October 17, 1989, an earthquake that registered 7. 1 on the Richter scale caused extensive damages to the Emporium division of Carter Hawley Hale Stores (CHHS), Inc. This memo explains how to properly report the earthquake damage costs in the income statement for the year ending August 4, 1990. The memo first defines extraordinary items as well as unusual or infrequent items, and then discusses why the damages are being reported as separate items on the income statement. Extraordinary Items
Extraordinary items, per the Financial Accounting Standards Board (FASB), are material events and transactions that are both unusual in nature and infrequent. FASB requires that entities report these items on the income statement in the following way: As seen in the image above, an extraordinary item must be reported separately, net of taxes. It must be an event or transaction that meets two criteria. First, the event must be unusual in nature; which means it possesses a high degree of abnormality and is clearly unrelated to the ordinary and typical activities of a company.
Next, the event must not be reasonably expected to occur again in the foreseeable future, these particular events are considered to have an infrequency of occurrence. In both requirements, an entity must take into account the environment in which it operates. (FASB-225-20-45-10)Income before extraordinary items $XXX Extraordinary items (less applicable income taxes of $ ) (Note ) XXX Net income $XXX Infrequency of occurrence items must take into account when the last time that certain event or transaction took place.
This will determine the probability of recurrence for a particular entity. Simply classifying an item to have an infrequency of occurrence does not imply that its effects should be classified as extraordinary. FASB clarifies that “an event or transaction of a type that occurs frequently in the environment in which the entity operates cannot, by definition, be considered as extraordinary, regardless of its financial effect. ” Recommendations
Based on the previously stated information, I have decided that the proper way to report the earthquake damage costs that CHHS has faced, is to classify the costs as having an infrequency of occurrence. In which case, “the [loss] should be included in continuing operations but reported as a separate income component [on the income statement] (Spiceland, 187). ” These costs cannot be classified as extraordinary items due to the fact that they do not meet both criteria; the event is not unusual but it is infrequent.
Conclusion It is not unusual for an earthquake to occur in the San Francisco area, but a 7. 1 Richter scale earthquake is quite infrequent. The loss that CHHS incurred cannot be classified as extraordinary and thus is not reported separately after taxes, it is however an infrequent event which means that it will be included in continuing operations, before taxes. Let me know if you have any further questions regarding the earthquake damage costs that CHHS incurred or how the damages should be reported.
Works Cited Financial Accounting Standards Board Accounting Standards Codification. FASB: Financial Accounting Standards Board. . -225-20-45-2 Criteria for Presentation as Extraordinary Items -225-20-45-10 Presentation of Extraordinary Items -225-20-55-2 Infrequency of Occurrence Spiceland, J. David, Sepe, James F. , Nelson, Mark W. “Chapter 4. ” Intermediate Accounting. Boston: McGraw-Hill/Irwin, 2010. 186-9. Print.