APPLICATION OF THE SUSTAINABLE EARNINGS BASE WORKSHEET: BAKER HUGHES INC.
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.
Most of the content of the Baker Hughes financial statements as well as relevant footnote and other textual information is provided. This is designed to make the exercise as realistic as possible.
Frequently Asked Questions
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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: 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 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: 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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