NONRECURRING ITEMS IN THE OTHER INCOME AND EXPENSE NOTE
An “other income (expense), net,” or equivalent line item is commonly found in both the single- and multistep income statement. In the case of the multistep format, the composition of other income and expenses is sometimes detailed on the face of the income statement. In both the multi- and single-step formats, the most typical presentation is a single line item with a supporting note. Even though a note detailing the contents of other income and expense may exist, companies typically do not specify its location. Other income and expense notes tend to be listed close to the end of the notes to the financial statements.
The other income and expense note of The Sherwin-Williams Company is provided in Exhibit 2.20. The balance (income) of the Sherwin-Williams other income and expense note shows a modest increase between 1997 to 1998 and
1998 to 1999. In the absence of sharp changes in the balance over time, an analyst would be less inclined to look for a note detailing the makeup of the balance on the face of the income statement. However, some large nonrecurring items underlie this net balance.
Notice the very large increase in the provision for environmental matters. This increase is in turn offset in part by the sharp decline in the provision for disposition and termination of operations. Similarly, the foreign currency loss declined by about $12 million over the three years covered by the note. Some or all of the large 1999 increase in the provision for environmental matters should be considered to be nonrecurring. This would mean that results for 1999 would appear somewhat stronger with the provision added back to earnings. Some or all of the $12 million provision for disposition and termination of operations should also be added back to results for 1998.
Foreign currency gains and losses usually are not treated as nonrecurring. However, the case was made in Exhibit 2.2 (Goodyear Tire and Rubber Company) for treating them as nonrecurring when they are very irregular, either in terms of amount or sign (i.e., gain versus loss). The Sherwin-Williams foreign currency loss declined by about $12 million between 1997 and 1999. Nonrecurring elements are included in at least three of the line items in the Sherwin-Williams other income and expense note. The net balance of the other income and expense line item has changed only modestly in the face of very substantial changes in the components of the net balance. The smooth and modest growth in this net balance contributes in turn to preserving the growth and stability of the bottom line, or net income. There is always the possibility that some of the offsetting balances in the Sherwin-Williams note were recorded for the purpose of producing smooth growth in this line item.
The location and careful analysis of the other income and expense note is especially important in the case of income statements with very little detail. In this regard, firm size and the level of detail in the income statement appear to
be inversely related. For example, excluding subtotals and the bottom line of the income statement, C.R. Bard had a total of only eight line items on its 1997 to 1999 income statements. However, its other income and expense note (Exhibit 2.21) includes numerous nonrecurring items.
A review only of C.R. Bard’s 1997 to 1999 income statements would have yielded a single nonrecurring item. Depending on what is judged to be nonrecurring, Bard’s other income and expense note yields an additional nine to eleven nonrecurring items. As with the Sherwin-Williams note, there is a tendency for nonrecurring items to offset each other. Notice that Bard booked a $24.5 million gain in 1997, when it also had a restructuring charge of $44.1 million. Also, an asset write-down of $34.1 million partially offset a $48.6 million gain from legal and patent settlements in 1998..
Careful analysis of the composition of other income and expense line items is very important in locating nonrecurring items. As the disclosures of both Sherwin-Williams and C.R. Bard illustrate, this task is made far easier if a note is provided detailing the line item’s composition. However, you should not expect to be guided to the note by a reference attached to this line item in the income statement.