NONRECURRING ITEMS IN THE OTHER INCOME AND EXPENSE NOTE




An “other income (expense), net,” or equivalent line item is commonly found in both the single- and multistep income statement. In the case of the multistep format, the composition of other income and expenses is sometimes detailed on the face of the income statement. In both the multi- and single-step formats, the most typical presentation is a single line item with a supporting note. Even though a note detailing the contents of other income and expense may exist, companies typically do not specify its location. Other income and expense notes tend to be listed close to the end of the notes to the financial statements.

The other income and expense note of The Sherwin-Williams Company is provided in Exhibit 2.20. The balance (income) of the Sherwin-Williams other income and expense note shows a modest increase between 1997 to 1998 and

NONRECURRING ITEMS IN THE OTHER INCOME AND EXPENSE NOTE

1998 to 1999. In the absence of sharp changes in the balance over time, an analyst would be less inclined to look for a note detailing the makeup of the balance on the face of the income statement. However, some large nonrecurring items underlie this net balance.

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Notice the very large increase in the provision for environmental matters. This increase is in turn offset in part by the sharp decline in the provision for disposition and termination of operations. Similarly, the foreign currency loss declined by about $12 million over the three years covered by the note. Some or all of the large 1999 increase in the provision for environmental matters should be considered to be nonrecurring. This would mean that results for 1999 would appear somewhat stronger with the provision added back to earnings. Some or all of the $12 million provision for disposition and termination of operations should also be added back to results for 1998.

Foreign currency gains and losses usually are not treated as nonrecurring. However, the case was made in Exhibit 2.2 (Goodyear Tire and Rubber Company) for treating them as nonrecurring when they are very irregular, either in terms of amount or sign (i.e., gain versus loss). The Sherwin-Williams foreign currency loss declined by about $12 million between 1997 and 1999. Nonrecurring elements are included in at least three of the line items in the Sherwin-Williams other income and expense note. The net balance of the other income and expense line item has changed only modestly in the face of very substantial changes in the components of the net balance. The smooth and modest growth in this net balance contributes in turn to preserving the growth and stability of the bottom line, or net income. There is always the possibility that some of the offsetting balances in the Sherwin-Williams note were recorded for the purpose of producing smooth growth in this line item.

The location and careful analysis of the other income and expense note is especially important in the case of income statements with very little detail. In this regard, firm size and the level of detail in the income statement appear to

NONRECURRING ITEMS IN THE OTHER INCOME AND EXPENSE NOTE

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be inversely related. For example, excluding subtotals and the bottom line of the income statement, C.R. Bard had a total of only eight line items on its 1997 to 1999 income statements. However, its other income and expense note (Exhibit 2.21) includes numerous nonrecurring items.

A review only of C.R. Bard’s 1997 to 1999 income statements would have yielded a single nonrecurring item. Depending on what is judged to be nonrecurring, Bard’s other income and expense note yields an additional nine to eleven nonrecurring items. As with the Sherwin-Williams note, there is a tendency for nonrecurring items to offset each other. Notice that Bard booked a $24.5 million gain in 1997, when it also had a restructuring charge of $44.1 million. Also, an asset write-down of $34.1 million partially offset a $48.6 million gain from legal and patent settlements in 1998..

Careful analysis of the composition of other income and expense line items is very important in locating nonrecurring items. As the disclosures of both Sherwin-Williams and C.R. Bard illustrate, this task is made far easier if a note is provided detailing the line item’s composition. However, you should not expect to be guided to the note by a reference attached to this line item in the income statement.



Frequently Asked Questions

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Ans: Income tax notes are among the more challenging of the disclosures found in annual reports. They can, however, be a rich source of information on nonrecurring items. Fortunately, our emphasis on the persistence of earnings requires a focus on a single key schedule found in the standard income tax note. The goal is simply to identify nonrecurring tax increases and decreases in this schedule. view more..
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Ans: The carrying values of inventories maintained under the LIFO method are sometimes significantly understated in relationship to their replacement cost. For public companies, the difference between the LIFO carrying value and replacement cost (frequently approximated by FIFO) is a required disclosure under SEC regulations. An example of a substantial difference between LIFO and current replacement value is found in a summary of the inventory disclosures of Handy and Harman Inc. in Exhibit 2.17. view more..
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Ans: After the income statement, the operating activities section of the statement of cash flows is an excellent secondary source to use in locating nonrecurring items (step 2 in the search sequence in Exhibit 2.3). The diagnostic value of this section of the statement of cash flows results from two factors. First, gains and losses on the sale of investments and fixed assets must be removed from net income in arriving at cash flow from operating activities. Second, noncash items of revenue or gain and expense or loss must also be removed from net income. view more..
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Ans: An “other income (expense), net,” or equivalent line item is commonly found in both the single- and multistep income statement. In the case of the multistep format, the composition of other income and expenses is sometimes detailed on the face of the income statement. In both the multi- and single-step formats, the most typical presentation is a single line item with a supporting note. Even though a note detailing the contents of other income and expense may exist, companies typically do not specify its location. Other income and expense notes tend to be listed close to the end of the notes to the financial statements view more..
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Ans: Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is an annual and a quarterly Securities and Exchange Commission reporting requirement. Provisions of this regulation have a direct bearing on the goal of locating nonrecurring items. As part of the MD&A, the SEC requires registrants to: view more..
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Ans: Typically, most material nonrecurring items will have been located by proceeding through the first six steps of the search sequence in Exhibit 2.3. However, some additional nonrecurring items may be located in other notes. Nonrecurring items can surface in virtually any note to the financial statements. We will now discuss three selected notes that frequently contain other nonrecurring items: notes on foreign exchange, restructuring, and quarterly and segment financial data. Recall that inventory, income tax, and other income and expense notes have already been discussed in steps 3 to 5. view more..
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Ans: The last section in the AK Steel Holdings income statement in Exhibit 2.9 is devoted to the reporting of other comprehensive income. This is a relatively new feature of the income statement and was introduced with the issuance by the FASB of SFAS No. 130, Reporting Comprehensive Income.44 The goal of the standard is to expand the concept of income to included selected items of nonrecurring revenue, gain, expense and loss. Under the new standard, traditional net income is combined with a new component, “other comprehensive income,” to produce a new bottom line, “comprehensive income.” view more..
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Ans: The work to this point has laid out important background but is not complete. Still required is a device to assist in summarizing information discovered on nonrecurring items so that new measures of sustainable earnings can be developed. We devote the balance of this chapter to introducing a worksheet specially designed to summarize nonrecurring items and illustrating its development and interpretation in a case study. view more..
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Ans: The sustainable earnings worksheet is shown in Exhibit 2.26. Detailed instructions on completing the worksheet follow: 1. Net income or loss is recorded on the top line of the worksheet. 2. All identified items of nonrecurring expense or loss, which were included in the income statement on a pretax basis, are recorded on the “add” lines provided. view more..
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Ans: The sustainable earnings base provides earnings information from which the distorting effects of nonrecurring items have been removed. Some analysts refer to such revised numbers as representing “core” or “underlying” earnings. Sustainable is used here in the sense that earnings devoid of nonrecurring items of revenue, gain, expense, and loss are much more likely to be maintained in the future, other things equal. Base implies that sustainable earnings provide the most reliable foundation or starting point for projections of future results. The more reliable such forecasts become, the less the likelihood that earnings surprises will result. Again, Phillips Petroleum captures the essence of nonrecurring items in the following: view more..
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Ans: This case example of using the SEB worksheet is based on the 1997 annual report of Baker Hughes Inc. and its results for 1995 to 1997. The income statement, statement of cash flows, management’s discussion and analysis of results of operations (MD&A), and selected notes are in Exhibits 2.27 through 2.34. Further, to reinforce the objective of efficiency in financial analysis, we adhere to the search sequence outlined in Exhibit 2.3. view more..
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Ans: The nonrecurring items located in the Baker Hughes annual report are enumerated in the completed SEB worksheet in Exhibit 2.35. Each of the nonrecurring items is recorded on the SEB worksheet. When an item is disclosed for the first, second, third, or fourth time, it is designated by a corresponding superscript view more..
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Ans: The construction of an SEB worksheet always requires a judgment call. One could, of course, avoid all materiality judgments by simply recording all nonrecurring items without regard to their materiality. However, the classification of items as nonrecurring, as well as on occasion their measurement, calls for varying degrees of judgment. Some examples of Baker Hughes items that required the exercise of judgment, either in terms of classification or measurement, are discussed next. view more..
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Ans: An estimation of the sustainable portion of earnings should be the centerpiece of analyzing business earnings. This task has become a far greater challenge over the past decade as the number of nonrecurring items has increased dramatically. This explosion has been driven by corporate reorganizations and associated activities. Some of the labels attached to these producers of nonrecurring items are restructuring, rightsizing, downsizing, reengineering, redeployment, repositioning, reorganizing, rationalizing, and realignment. view more..
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Ans: Abigail Peabody was a very well-known nature photographer. Over the years she had had a number of best-sellers, and her books adorned the coffee tables of many households worldwide. On this particular day she was contemplating her golden years, which were fast approaching. In particular she was reviewing her year-end investment report and wondering why she was not better prepared. After all, she had been featured in the Sunday New York Times book section, had discussed her works with Martha Stewart, and had been the keynote speaker at the Audubon Society’s annual fund-raiser. She knew it was not her investment advisers’ fault. Their performance over the past years had been better than many of the market indixes. She wondered if she was just a poor businessperson. view more..




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