94 Understanding the Numbers
Hughes disclosed that it recognized equity income from Varco of $3.2 million in
1995 and $1.8 million in 1996. However, the disposal of the Varco investment
did not qualify as a discontinued operation. If it had been so classified, then the
Baker Hughes share of earnings would have been removed from income from
continuing operations of 1995 and 1996 and reported with discontinued opera-
tions—along with the gain on the disposition of the investment.
Clearly, a case could be made for treating the 1995 and 1996 equity earn-
ings as nonrecurring and removing them from earnings in developing the SEB
worksheet. This would not alter the message conveyed by the SEB worksheet in
this particular case. However, if the effect were more material, then a judg-
ment to treat as nonrecurring the equity earnings from the Varco investment
would be in order.
Using the Summary Disclosures of Unusual Charges
In completing the worksheet, the summary totals from the unusual-charge dis-
closures (Exhibit 2.33) were used. Alternatively, the detail on the charges
could have been recorded in appropriate lines in the worksheet. We saw this as
of fer ing no advantage here.
Having the detail on the makeup of the unusual charges is helpful in de-
termining whether other additional nonrecurring items have already been in-
cluded in these totals. Recall that the 1997 Petrolite inventory adjustment of
$21.9 million was not included in the unusual charges total (it was included in
cost of sales). Summaries for unusual charges, it should be noted, usually do
not include all items that could reasonably be considered nonrecurring. In ad-
dition, care should be taken not to duplicate the recording of items already in-
cluded in summary totals for unusual charges.
SUMMARY
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 dra-
matically. This explosion has been driven by corporate reorganizations and
associated activities. Some of the labels attached to these producers of non-
recurring items are restructuring, rightsizing, downsizing, reengineering, re-
deployment, repositioning, reorganizing, rationalizing, and realignment. The
following are some key points for the reader to consider:
- An earnings series from which nonrecurring items have been purged is
essential in order to both evaluate current trends in operating perfor-
mance and make projections of future results. - The identification and measurement of nonrecurring items will typically
require the exercise of judgment.