6. Non-Recurring Items and Non-Operating Items
f. describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, extraordinary items, unusual or infrequent items) and changes in accounting standards;
g. distinguish between the operating and non-operating components of the income statement;
What are "non-recurring items" on an income statement?
Net income includes the impact of non-recurring items, which are transitory or random in nature. Management tends to label many items in the income statement as "non-recurring," especially those that reduce reported income. For the purpose of analysis, an important issue is to assess whether non-recurring items are really "non-recurring," regardless of their accounting labels.
What are the four types of non-recurring items on an income statement?
1. Discontinued operations - not a component of persistent or recurring net income from continuing operations.
2. Extraordinary items - BOTH unusual in nature AND infrequent in occurrence, and material in amount.
3. Unusual or infrequent items - either unusual in nature OR infrequent in occurrence but not both.
4. Changes in accounting principles -
What is it important for an analyst to scrutinize whether non-recurring items are truly "non-recurring"?
The goal of analyzing an income statement is to derive an effective indicator to predict future earnings and cash flows. Net income includes the impact of non-recurring items, which are transitory or random in nature. Therefore, net income is not the best indicator of future income. Recurring pre-tax income from continuing operations represents the company's sustainable income and therefore should be the primary focus of analysis. Generally, analysts should exclude items that are non-recurring in nature when predicting a company's future earnings and cash flows.