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Explain non-recurring items and how analysts adjust for them

CFA® Level I · Financial Statement Analysis · Analyzing Income Statements · FSA.1.d

The idea

Discontinued operations are reported separately, net of tax, because the associated assets and results will not recur. Unusual or infrequent items remain within continuing operations but are disclosed. Changes in accounting principle are applied retrospectively, while changes in estimate are applied prospectively, and the difference matters because only the first restates prior periods. For analysis the question is not what the company labels non-recurring but what will actually recur: a restructuring charge taken in five of the last six years is a cost of doing business however it is presented.

A practice question

From the question bank, with the reason each wrong option is wrong.

How are discontinued operations presented?

  1. Within operating expensesWhy not: Burying them there defeats the purpose of the line, which exists so continuing operations can be read on their own.
  2. Separately from continuing operations, net of tax — correct
  3. Only in the notesWhy not: They appear on the face of the income statement, as their own line below continuing operations.

Separating them lets a reader assess the results of the business that will continue, which is the one relevant to forecasting.

A harder one

Why does the distinction between a principle change and an estimate change matter to an analyst?

  1. Only one restates the comparatives, so only one leaves the trend comparable — correct
  2. Only one requires auditor approvalWhy not: Both are subject to audit, and neither is the auditor's to approve — the company makes the change and the auditor assesses whether it is justified and disclosed.
  3. Only one affects cash flowWhy not: Neither affects cash. Both are presentational and accrual-side; the cash consequences of the underlying transactions are unchanged.

A principle change restates history so the series stays comparable. An estimate change creates a break in the trend that has to be allowed for.

The hardest tier

A company has recorded a restructuring charge in five of the last six years and presents each as non-recurring. How should an analyst treat them?

  1. Exclude them all, since management has identified them as non-recurringWhy not: The label is management's; the frequency is a fact. Excluding all six produces an earnings figure the company has never once reported.
  2. Exclude them only from the most recent yearWhy not: That makes the latest year incomparable with the others while still accepting the label. A charge appearing five years in six is a cost of the business in every one of them.
  3. Treat them as a recurring cost — correct

Frequency is what determines recurrence, not the label. Serial restructuring is an operating characteristic, and accepting the label would produce an adjusted earnings figure the company has never once achieved.

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