THE PROCESS OF IDENTIFYING NONRECURRING ITEMS



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Careful analysis of past financial performance aimed at removing the effects of nonrecurring items is a more formidable task than one might suspect. This task would be fairly simple if (1) there was general agreement on just what constitutes a nonrecurring item and (2) if most nonrecurring items were prominently displayed on the face of the income statement. However, neither is the case. Some research suggests that fewer than one-fourth of nonrecurring items are likely to be found separately disclosed in the income statement. Providing guidance for locating the remaining three-fourths is a key goal of this chapter.

Identifying Nonrecurring Items: An Efficient Search Procedure

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The search sequence outlined in the following discussion locates a high cumulative percentage of material nonrecurring items and does so in a cost-effective manner. Search cost, mainly in time spent by the financial analyst, is an important consideration. Time devoted to this task is not available for another and, therefore, there is an opportunity cost to consider. The discussion and guidance that follows are organized around this recommended search sequence (see Exhibit 2.3). Following only the first five steps in this search sequence is likely to locate almost 60% of all nonrecurring items.9 Continuing through steps six and seven will typically increase this location percentage. However, the 60% discovery rate is higher if the focus is only on material nonrecurring items. The nonrecurring items disclosed in other locations through steps 6 and 7 are fewer in number and normally less material than those initially found through the first five.


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