5
Things To Know About Exceptional Items In Company Balance Sheets
In the quarter gone by, a lot of
companies reported Exceptional items in their balance sheets. Read the article
to understand what you can make of it.
Reading
and analyzing a company’s business is no less than an art. It needs careful
understanding, especially when you are using it to invest in stocks. It’s not
enough to just compare the growth in profits and revenue. It is equally
important to know if the trend will continue. For this, one of the things to
look for is ‘Exceptional Items’.
·
What Are Exceptional Items
As the name suggests,
these are one-off events that either caused a great expense or a big bout of
revenue. For example, suppose a company sold off some of its machinery because
it did not use it anymore. This led to an income of Rs 1 crore – a big sum for
a single transaction. This could easily boost the company’s profits in that
particular quarter/year. However, this is not likely to recur again. So, it is
counted as an ‘Exceptional Item’.
·
Different From Extraordinary Items
Don’t confuse it, however,
with ‘Extraordinary Items’. The key difference lies in whether or not the item
is related to the company’s regular operations. Selling machinery (from the
previous example) is a part of the company’s operations, although not one
conducted every quarter or year. Extraordinary items, however, are not part of
the regular operations. For example, a flood damaging company equipment or loss
in production due to labour strike can be considered Extraordinary Items.
·
Why Do They Matter
While they may be
different, both Exceptional and Extraordinary Items are important. First, it
can provide insight into the financial repercussions of certain events and
company decisions. For example, Asian Paints reported a Rs 52.5-crore expense
due to loss of goodwill related to a company acquisition in its recent result.
This is vital information when calculating the profitability of its investment
in the new company. Secondly, exceptional and extraordinary items are important
while calculating the actual growth in the business.
·
Use In Company Analysis
Exceptional items as well
as Extraordinary Items are reported in the Profit and Loss statement. A
detailed explanation regarding the nature of the item is given in the notes to
accounts. It is in the best interest of the investor to look for recurring profit
to make any judgement regarding the performance of the company. To do this,
analysts usually adjust the Net Profit or Operating Profit for these items by
subtracting the expense/income as well as its tax. The idea is that since these
items do not recur on a regular basis so taking them out of the picture is
likely to give a truer account of the business.
·
Window Dressing
It
is also important that you look at Exceptional and Extraordinary Items.
Companies have to give explanations for these Items in their financial reports.
That said, it can also be manipulated to make the company’s balance sheet look
better. This is called ‘Window Dressing’. So, do read the details of these
Items and check for the explanations.
The accounting standards define some of the key exceptional items as
follows:
The write down of inventories to net realizable value
Disposal of items of fixed assets
Disposal of long term investments
Legislative changes having retrospective application like
increase in dearness allowance with retrospective effect
Litigation Settlement.
