36 Understanding the Numbers
provides one such example. Exhibit 2.1 shows a Mason Dixon schedule that ad-
justs reported net income to a revised earnings measure from which nonrecur-
ring revenues, gains, expenses, and losses have been removed. This is the type
of information that the previously quoted statement of the AICPA’s Special
Committee calls for.
Notice the substantial number of nonrecurring items that Mason Dixon
removed from reported net income in order to arrive at a closer measure of
core or sustainable earnings. In spite of the number of nonrecurring items re-
moved from reported net income, the revised earnings differ by only about 6%
from the original reported net income.
Firms that record either a large nonrecurring gain or loss frequently at-
tempt to offset its effect on net income by recording a number of offsetting
items. In the case of Mason Dixon, the large gain on the sale of branches if not
offset may raise earnings expectations to levels that are unattainable. Alterna-
tively, the recording of offsetting charges may be seen as a way to relieve fu-
ture earnings of their burden. We do not claim that this was done in the case of
Mason Dixon Bancshares, but its results are consistent with this practice.
Though exceptions like the Mason Dixon Bancshares example do occur,
the task of developing information on a firm’s recurring or sustainable results
normally falls to the statement user. Companies do provide, to varying degrees,
the raw materials for this analysis; however, the formidable task of creating—an
analysis comparable to that provided by Mason Dixon—is typically left to the
user. The central goal of this chapter is to help users develop the background
and skills to perform this critical aspect of earnings analysis. The chapter will
discuss nonrecurring items and outline efficient approaches for locating them in
financial statements and associated notes. As key background we will also dis-
cuss and illustrate income statement formats and other issues of classification.
Throughout the chapter, we illustrate concepts using information drawn from
EXHIBIT 2.1 Core business net income: Mason Dixon Bancshares Inc.,
year ended December 31 (in thousands).
1998
Reported net income $10,811
Adjustments, add (deduct), for nonrecurring items:
Gain on sale of branches (6,717)
Special loan provision for loans with Year 2000 risk 918
Special loan provision for change in charge-off policy 2,000
Reorganization costs 465
Year 2000 costs 700
Impairment loss on mortgage sub-servicing rights 841
Income tax expense on the nonrecurring items above 1,128
Core (sustainable) net income $10,146
SOURCE: Mason Dixon Bancshares Inc., annual report, December 1998. Information obtained from
Disclosure, Inc., Compact D/SEC: Corporate Information on Public Companies Filing with the SEC
(Bethesda, MD: Disclosure Inc., June 2000).