58 Understanding the Numbers
operating cash f low. This deduction may indicate either that no cash was col-
lected in connection with recording this income or that the income is not con-
sidered to be an operating cash-f low item. The absence of a cash inf low is the
more likely explanation. But should the $75,000 be seen as nonrecurring? If
this were a one-time licensing fee, then it should be treated as nonrecurring
in evaluating the $171,472 of 1998 net income. Escalon has a substantial
net-operating-loss carryfor ward, and its 1998 pretax and after-tax results are
the same. As a result, this $75,000 of income amounted to 44% of Escalon’s
1998 net income. The absence of this item in the cash f lows statement in either
1999 or 2000 gives the licensing fee the appearance of being nonrecurring.
NONRECURRING ITEMS IN THE INVENTORY
DISCLOSURES OF LIFO FIRMS
The carrying values of inventories maintained under the LIFO method are
sometimes significantly understated in relationship to their replacement cost.
For public companies, the difference between the LIFO carrying value and
replacement cost (frequently approximated by FIFO) is a required disclosure
under SEC regulations.^22 An example of a substantial difference between
LIFO and current replacement value is found in a summary of the inventory
disclosures of Handy and Harman Inc. in Exhibit 2.17.
A reduction in the physical inventory quantities of a LIFO inventory is
called a LIFO liquidation. With a LIFO liquidation a portion of the firm’s cost
of sales for the year will consist of the carrying values associated with the liq-
uidated units. These costs are typically lower than current replacement costs,
resulting in increased profits or reduced losses.
As with the differences between the LIFO cost and the replacement
value of the LIFO inventory, SEC regulations also call for disclosures of the ef-
fect of LIFO liquidations.^23 Handy and Harman had LIFO liquidations in both
1996 and 1997. In line with these SEC requirements, Handy and Harman pro-
vided the following disclosure of the effects of these inventory reductions:
Included in continuing operations for 1996 and 1997 are profits before taxes of
$33,630,000 and $6,408,000, respectively, from reduction in the quantities ofEXHIBIT 2.17 LIFO inventory valuation differences: Handy and Harman
Inc. inventory footnote, years ended December 31
(in thousands).
1996 1997
Precious metals stated at LIFO cost $24,763 $ 20,960
LIFO inventory—excess of year-end market value over LIFO cost 97,996 106,201
SOURCE: Data obtained from Disclosure Inc., Compact D/SEC: Corporate Information on Public Com-
panies Filing with the SEC(Bethesda, MD: Disclosure Inc., June 1998).