Analyzing Business Earnings 43The Nature of Operating Income
Operating income is designed to ref lect the revenues, gains, expenses, and losses
that are related to the fundamental operating activities of the firm. Notice, how-
ever, that the Toys “R” Us operating loss for the year ending January 30, 1999,
included two nonrecurring charges. These were the asset write-offs and a re-
structuring charge. While operating income or loss may include only operations-
related items, some of these items may be nonrecurring. Hence, operating
income is not the “sustainable” earnings measure called for in our opening quote
from the AICPA Special Committee on Financial Reporting. Even at this early
point in the operations section of the income statement, nonrecurring items have
been introduced that will require adjustment in order to arrive at an earnings
base “that provides a basis for estimating sustainable earnings.”^11 Also be aware
that “operating income” in a multistep format is an earlier subtotal than “income
from continuing operations.” Moreover, operating income is a pretax measure,
whereas income from continuing operations is after tax. A more extensive sam-
pling of items included in operating income is provided next.
Nonrecurring Items Included in Operating Income
Reviewing current annual reports reveals that corporations very often include
nonrecurring revenues, gains, expenses, and losses in operating income. A
sample of nonrecurring items included in the operating income section of
multistep income statements is provided in Exhibit 2.6. As is typical, nonre-
curring expenses and losses are more numerous than nonrecurring revenues
and gains. This imbalance is due in part to GAAP, which require firms to rec-
ognize unrealized losses but not unrealized gains. Moreover, fundamental ac-
counting conventions, such as the historical cost concept and conservatism,
may also provide part of the explanation.
Many of the nonrecurring expense or loss items involve declines in the
value of specific assets. Restructuring charges have been among the most com-
mon items in recent years in this section of the income statement. These
charges involve asset write-downs and liability accruals that will be paid off in
future years. Seldom is revenue or gain recorded as a result of writing up as-
sets. Further, unlike the case of restructuring charges, the favorable future
consequences of a management action would seldom support current accrual of
revenue or gain.
There is substantial variety in the nonrecurring expenses and losses in-
cluded in operating income. Many of the listed items appear closely linked to
operations, and their classification seems appropriate. However, some appear
to be at the fringes of normal operating items. Examples related to expenses
and losses include the f lood costs of Argosy Gaming, merger-related charges
incurred by Brooktrout Technologies, the embezzlement loss of Osmonics, and
the loss on the sale of Veeco Instruments’ leak detection business. Among the
gains, the Fairchild and H.J. Heinz gains on selling off businesses would seem
to be candidates for inclusion further down the income statement.