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17/12/2020 06:04:37 PM

Alternative Income Classifications and Measures (Part 1)

Proper income classification is important in analysis. Income can be classified along two major dimensions: (1) operating versus non-operating and (2) recurring versus nonre­curring. Many times, these two dimensions of classification are used synonymously. For example, certain analysts (and even certain companies) refer to an income measure that excludes all nonrecurring items as operating income. While it may be true that a majority of operating income components tend to be recurring, it must be understood that these two classifications are distinct, both in nature and purpose. For example, a nonrecurring item such as loss of inventory from fire is an operating loss. Similarly, a non-operating item such as interest income may be recurring in nature. The operating versus non-operating classification depends primarily on the source of the revenue or expense—namely, whether it arises from the ongoing operations of the company or from its securities transactions or financing activities. The recurring versus nonrecurring classification depends primarily on the behavior of the revenue or expense-namely, whether it is expected to persist or it is a one-time event. It is important for an analyst to appreciate the differences between these alternative classifications. Exhibit 6.2 stresses the distinction in these dimensions of classifying income
  1. Recurring and Nonrecurring Income

Income statements typically report three alternative income measures: (1) net income, (2) comprehensive income, and (3) continu­ing income. Net income is regarded as the bottom line measure of income. In reality, it is not. GAAP allows a number of direct adjustments to equity, called dirty surplus items, that bypass the income statement. SEAS 130 attempts to remedy this problem with an al­ternative measure of income called comprehensive income. Comprehensive income reflects nearly all changes to equity, other than those from owner activities (such as div­idends and share issuances). This implies that comprehensive income is the bottom-line measure of income, and is the accountant’s proxy for economic income. Unfortunately, companies are allowed to report comprehensive income in the statement of changes in equity instead of the income statement. Comprehensive income differs from net income in that it reflects certain unrealized holding gains and losses foreign currency translation adjustments, and minimum pension liability adjustments (not reported are derivative gains and losses which also affect comprehensive income).

Accountants also report an intermediate measure of income called continuing income. Continuing income is a measure that excludes extraordinary items, cumulative effects of accounting changes, and the effects of discontinued operations. For this reason, con­tinuing income is often called income before extraordinary items; income before discontinued operations, or income before cumulative effect of accounting change, or any combination as appropriate. Companies without these components need not report continuing income