Extraordinary Losses

Memorandum

From: Stalwart and Honest

Subject: Extraordinary Losses

The objectives of accounting are to provide information that aids financial statement users in assessing the amounts, timings and uncertainties of future cash flows. This is done through providing relevant and faithfully representational information. As auditors, we at Stalwart and Honest do not just stake our reputation on providing information that is useful to our customers and their financial statement users, we stake our business on it. While classifying your latest write-offs as an extraordinary loss is a prudent business decision as far as operating profit is concerned, we had to debate long and hard if it was an appropriate accounting decision.

Looking at the criteria for extraordinary items they need to be both unusual in nature and infrequent in occurrence, given their environment (ASC 225-20-45). Unusual in nature means a high degree of abnormality and unrelated to the ordinary activities of the entity. This is not impacted by whether or not it is something management can control (ASC 225-20-55-1). Infrequent in occurrence means it would not reasonably be expected to recur in the future. It is important to note that while it is your first year of operation, business “norms” can reasonably be extrapolated from your industry environment (ASC 225-20-55). Additionally while you might enact a policy refusing to extend credit to any further customers, there is no guarantee this policy will stay consistent. For instance, consider if your company is sold to new management, and they no longer follow this policy. Due to these reasons we have decided to reject authorizing this reclassification.

By classifying your losses as extraordinary, you will be providing more opaque data. While your net income will be unchanged, the numbers leading to it will be drastically different. Numbers representing bad debt expense, operating income, and net income before taxes are relevant to external...