92 Understanding the Numbers
Column 3: Same as column 1 except only material nonrecurring items
(those items exceeding 5% of net income on an after-tax
basis).
Column 4: Same as column 2 except that only material nonrecurring
items were considered.SOME FURTHER POINTS ON THE
BAKER HUGHES WORKSHEET
The construction of an SEB worksheet always requires a judgment call. One
could, of course, avoid all materiality judgments by simply recording all nonre-
curring 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 re-
quired the exercise of judgment, either in terms of classification or measure-
ment, are discussed next.
The Petrolite Inventory Adjustment
A pretax addition was made in Exhibit 2.35 for the effect on 1997 earnings of
inventory obtained with the Petrolite acquisition (see Exhibits 2.30 and 2.34).
Accounting requirements for purchases call for adjusting acquired assets to
their fair values. This adjustment required a $21.9 million increase in Petrolite
inventories to change them from cost to selling price. This meant that there
was no profit margin on the subsequent sale of this inventory in the fourth
quarter of 1997. That is, cost of sales was equal to the sales amount. Baker
Hughes labeled this $21.9 million acquisition adjustment “nonrecurring
charge to cost of sales for Petrolite inventories” (see segment disclosures in
Exhibit 2.34).
This Petrolite inventory charge raised the level of cost of sales in relation-
ship to sales. However, this temporary increase in the cost-of-sales percentage
(cost of sales divided by sales) was not expected to persist in the future. We
concurred with the Baker Hughes judgment and treated this $21.9 million
cost-of-sales component as a nonrecurring item in developing sustainable
earnings.
Foreign Exchange Gains and Losses
Information on foreign exchange gains and losses was disclosed in the state-
ment of cash f lows (Exhibit 2.28) and in the MD&A (Exhibit 2.30). The state-
ment of cash f lows disclosed foreign-currency losses of $1.9 million in 1995
and $8.9 million in 1996. A $6.1 million gain was disclosed in 1997. However,
the MD&A disclosed a foreign-currency loss of $11.4 million for 1996 and a
gain of $4.1 million for 1997. The foreign-currency items in the statement of