What it means
Companies want to show investors and managers what they earn from their usual activities. If a single big event, such as closing a factory or settling a lawsuit, were buried inside normal costs, profit for the year would look misleading.
For this reason, firms flag special items on the income statement or in the notes. They are typically unusual in nature, infrequent, or both, and they are explained so that the reader can decide how much weight to give them.
Analysts often calculate an adjusted or underlying profit that excludes special items. This makes comparisons across years and between companies easier, because a one-off charge no longer hides the trend.
There is a danger, though. Some companies label costs as special that actually recur year after year, which flatters adjusted profit, so readers should check how often the same kind of item appears.
Accounting standards and regulators set rules on what can be presented separately, and the terms used vary by country. As a manager, the useful habit is to ask what the item was, whether it will recur and what it did to cash.
Special items affect tax as well. The tax effect is usually shown alongside the item, so a pre-tax charge is reduced by the related tax saving to reach the after-tax impact.
Without this adjustment, an analyst would overstate the effect on profit.
In practice
Real-world examples.
Example
A manufacturer closes an old plant and pays $3,000,000 in redundancy and site clearance costs. The costs are listed as a special item, so shareholders can see that the underlying margin of the remaining plants is still 12%. They can then compare it with competitors on a like-for-like basis.
Example
A software company sells a small division for a gain of $2,000,000 above its book value. The gain is shown separately, and analysts exclude it when estimating next year's earnings because it will not recur. Reported profit rises that year, but the underlying business has not improved.
Example
A retailer loses a legal case and pays a one-off settlement of $800,000. The finance team reports it as a special item and notes in the accounts that no similar claims are expected. Auditors ask for evidence supporting that statement.
Formula
Calculation
After-tax special item = pre-tax special item x (1 - tax rate)
Adjusted net income = reported net income + after-tax special charges - after-tax special gains
A company reports net income of $5,000,000, which includes a restructuring charge of $1,500,000 before tax. With a tax rate of 20%, the after-tax charge is 1,500,000 x (1 - 0.20) = $1,200,000. Adjusted net income = 5,000,000 + 1,200,000 = $6,200,000, which shows what profit would have been without the one-off restructuring. The difference of $1,200,000 is the true after-tax cost of the closure. If the item had been a gain instead, the adjustment would run the other way and lower adjusted income.Case study
Seen in the real world.
Oakmere Foods is an illustrative, fictional food producer that reported a drop in profit from $9,000,000 to $4,000,000. Headlines said the business was struggling, but the finance director pointed to a $6,000,000 pre-tax impairment charge on a closed factory.
After a 20% tax saving, the after-tax special item was 6,000,000 x 0.80 = $4,800,000. Excluding it, adjusted profit was 4,000,000 + 4,800,000 = $8,800,000, only slightly below the prior year. The company's press release showed both figures side by side so readers could see the bridge.
The illustrative finance director also reminded investors that the company had reported a special restructuring charge in three years out of the last five. Analysts therefore treated part of the cost as a normal cost of doing business, and the company promised to be stricter about what it called special. Its audit committee agreed to review all such labels each year.
Watch out
Common mistakes.
- Ignoring special items entirely and assuming adjusted profit is the true profit, when the cash and costs are real and may recur.
- Accepting a company's label of special without checking whether similar items appear every year, because a repeated special cost is really part of normal operations.
- Forgetting to adjust for tax when removing a special item from profit.
Questions
People also ask.
Are special items the same as extraordinary items?
Not exactly, because modern accounting rules limit the use of extraordinary items, while special items is a broader, more informal description of unusual or infrequent items.
Do special items affect cash flow?
Some do, such as redundancy payments, while others, like non-cash write-downs, do not, so check the cash flow statement. The notes to the accounts usually explain which is which.
Why do analysts adjust for them?
To compare underlying performance across periods and companies, without one-off events distorting the picture. They also look at cash flow to confirm the underlying result.
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