Many income statements start out normally: sales revenue less the expenses of making sales and operating the business. But then there's a jarring layer of extraordinary gains and losses on the way down to the final profit line. (I discuss extraordinary gains and losses in Chapter 4.) In these situations, there are two bottom lines: one for profit from normal, ordinary, ongoing operations; and a second for the effect from the abnormal, extraordinary, nonrecurring gains and losses. The final profit line is the net result of the two components in the income statement. (EPS is reported before and after the unusual items.) What's a financial statement reader to do when a business reports such gains and losses?
There's no easy answer to this question. You could blithely assume that these things happen to a business only once in a blue moon and should not disrupt the business's ability to make profit on a sustainable basis. I call this the earthquake mentality approach: When there's an earthquake, there's a lot of damage, but most years have no tremors and go along as normal. Extraordinary gains and losses are supposed to be nonrecurring in nature and recorded infrequently, or one-time gains and losses. In actual practice, however, many businesses report these gains and losses on a regular and recurring basis — like having an earthquake every year or so.
|