40 Understanding the Numbers
components of earnings. Generally accepted accounting principles (GAAPs)
determine the structure and content of the income statement. Locating nonre-
curring items in the income statement is a highly efficient and cost-effective
process. Many nonrecurring items will be prominently displayed on separate
lines in the statement. Further, leads to other nonrecurring items, disclosed
elsewhere, may be discovered during this process. For example, a line item that
summarizes items of other income and expense may include an associated note
reference detailing its contents. These notes should always be reviewed—step
5 in the search sequence—because they will often reveal a wide range of non-
recurring items.
Alternative Income Statement Formats
Examples of the two principal income statement formats under current GAAPs
are presented below. The income statement of Shaw Industries Inc., in Ex-
hibit 2.4 is single stepand that of Toys “R” Us Inc. in Exhibit 2.5 is multistep.
An annual survey of financial statements conducted by the American Institute
of Certified Public Accountants (AICPA) reveals that about one-third of the
600 companies in its survey use the single-step format and the other two-thirds
the multistep.^10
EXHIBIT 2.3 Efficient search sequence for nonrecurring items.
Search
Step Search Location
1 Income statement.
2 Statement of cash f lows—operating activities section only.
3 Inventory note, generally assuming that the firm employs the LIFO inventory
method. However, even with non-LIFO firms, inventory notes may reveal
inventory write-downs.
4 Income tax note, with attention focused on the tax-reconciliation schedule.
5 Other income (expense) note in cases where this balance is not detailed on the
face of the income statement.
6 MD&A of Financial Condition and Results of Operations—a Securities and
Exchange Commission requirement and therefore available only for public
companies.
7 Other notes which often include nonrecurring items:
Note Nonrecurring items revealed
a. Property and equipment Gains and losses on asset sales
b. Long-term debt Foreign currency and debt-retirement gains and losses.
c. Foreign currency Foreign currency gains and losses
d. Restructuring Current and prospective impact of of restructuring
activities
e. Contingencies Prospective revenues and expenses
f. Segment disclosures Various nonrecurring items
g. Quarterly financial data Various nonrecurring items