Treatment of Extraordinary Bad Debt Expenses in EBITDA, NWC and Net Debt
In case of a non-recurring bad debt expense, we add it back to EBITDA in both the direct method and the allowance method.
What is its treatment in Net Working Capital in the direct method and the allowance method?
And what is its impact on Net Debt in both of these these methods?
Treatment of Extraordinary and Non-Recurring Expenses
Extraordinary items are gains or losses in a company's financial statements that are infrequent and unusual. An item is deemed extraordinary if it is not part of a company's ordinary, day-to-day operations and it has a material impact on the company. A material impact means that it has a significant effect on a firm's profitability and should, therefore, be broken out separately.
Detailed explanations of an extraordinary item must be included in the notes to the financial statements in a company's annual reports or financial filings with the Securities and Exchange Commission (SEC). It represents a one-time expense involving an unpredictable event.
International Financial Reporting Standards (IFRS) does not recognize the concept of an extraordinary item, which has led to the practice of classifying extraordinary items as separate from nonrecurring items to become obsolete.
Common extraordinary items include damage from natural disasters, such as earthquakes and hurricanes, damages caused by fires, gains or losses from the early repayment of debt, and write-offs of intangible assets.
A nonrecurring item refers to an entry that appears on a company's financial statements that is unlikely to happen again and is considered to be infrequent or unusual.
There are many examples of nonrecurring items. These can include litigation charges, charges related to letting workers go, restructuring charges to realign a business or operating unit (including mergers), gains or losses from the sale of assets, write-offs or write-downs related to business operations, and losses related to shutting down a business unit.
Accountants spend considerable time determining whether an item should be qualified as extraordinary or nonrecurring. Financial Accounting Standards Board (FASB) statement No.145 helps stipulate the accounting charges that can rightfully be considered extraordinary.
IFRS OR GAAP
It is important to note that International Financial Reporting Standards (IFRS) does not recognize the concept of an extraordinary item.
U.S. generally accepted accounting principles (GAAP) makes more of a distinction, such as with the extraordinary item discussion above that covered the unusual and infrequent differences. In this respect, a nonrecurring item might qualify as an unusual or infrequent item, but not both.
Since 2015, however, the difference between extraordinary items and nonrecurring items is not necessary for some countries due to tax reasons. Extraordinary items received beneficial tax treatment in comparison to non-extraordinary items under GAAP. These tax treatments have vanished, for the most part, making the distinction between extraordinary items and non-extraordinary items unnecessary, particularly since defining an extraordinary item was largely a subjective exercise.
Most financial literature tends to lump one-time items together and focus on separating them from those that are likely to recur in the future. In many cases, this is fine because the most important exercise in analyzing a firm's financial statements is separating recurring from nonrecurring items.
However, there are differences to note. For instance, nonrecurring items are recorded under operating expenses in the net income statement. By contrast, extraordinary items are most commonly listed after the bottom line net income figure. They are also usually provided after taxes and must be explained in the notes to the financial statements.
- Extraordinary items are gains or losses in a company's financial statements that are unlikely to happen again.
- A nonrecurring item refers to an entry that is infrequent or unusual that appears on a company's financial statements.
- The difference between extraordinary items and nonrecurring items is often subjective, and therefore extraordinary items are often lumped under nonrecurring items.
- The International Financial Reporting Standards (IFRS) does not recognize extraordinary items, only nonrecurring items.
- Generally accepted accounting principles (GAAP) makes more of a distinction between the two but this has become less common as the tax advantages of extraordinary items have disappeared.