Non-recurring items, discontinued operations and accounting changes

Which parts of this year’s profit will happen again?

Only profit from continuing, recurring operations is a good base for a forecast. Everything else has to be identified and set aside. The income statement helps by presenting three kinds of one-offs differently.

Item	Where it appears	Pretax or after tax	Analyst view
Discontinued operation	Separate line below income from continuing operations	Net of tax	Exclude from forecasts
Unusual or infrequent item	Inside continuing operations, separately disclosed if material	Pretax	Judge whether it really is a one-off
Non-operating item	Separate from operating items	Pretax	Analyze apart from operations

Items that distort this yearforecast from recurring continuing operations

• Discontinued operations Memorize a component sold, abandoned or held for sale
  • Separate line, net of tax below income from continuing operations
• Unusual or infrequent items Use it restructuring, asset sale gains and losses, write-downs
  • Stay in continuing operations pretax, disclosed separately if material
• Non-operating items Know the idea interest, investment income

Neither International Financial Reporting Standards (IFRS) nor US generally accepted accounting principles (GAAP) allows “extraordinary items” any more, so a surprising item that is not a discontinued operation sits in continuing operations. IFRS does not have an “unusual or infrequent” category by name but requires separate presentation of material items so users can see the effect.

What is a discontinued operation?

A component the company has sold, abandoned or classified as held for sale, which can be told apart from the rest of the business physically and operationally. Its results are shown on one line below income from continuing operations, net of tax, and prior years are re-presented the same way.

Discontinued operations are net of tax so that income from continuing operations stays clean. They do not include restructuring charges or a loss on closing one plant, which stay in continuing operations.

$$\text{After-tax result} = \text{Pretax result} \times (1 - t)$$

Unusual or infrequent items stay in continuing operations, are pretax, and are disclosed separately if material. Use judgment: if a company reports a “one-off” plant closure three years running, it is a recurring cost, and you should leave it in the forecast.

Go deeper Held-for-sale assets and the US GAAP versus IFRS definitions

Assets held for sale are measured at the lower of their carrying amount and fair value less costs to sell, and are no longer depreciated. IFRS defines a discontinued operation as a component that has been disposed of or is held for sale and represents a separate major line of business or geographic area. US GAAP asks whether the disposal is a strategic shift with a major effect on operations. The exam tests the presentation (net of tax, separate line), not the fine print.

What happens when the accounting changes?

It depends on what changed. A different method (a policy) is applied retrospectively. A revised judgment (an estimate) is applied prospectively. A mistake is corrected by restating.

Change in the numbers

• Change in accounting policy Memorize a different accepted method
  • Retrospective restate prior periods shown
• Change in accounting estimate Memorize a revised judgment, like useful life
  • Prospective current and future periods only
• Correction of a prior-period error Use it
  • Restate prior periods and disclose the nature of the error

A change in accounting policy means moving to another acceptable method, such as from weighted average cost to first in, first out (FIFO) for inventory. Retrospective application restates the earlier periods shown, so the trend is comparable and the cumulative effect goes into opening retained earnings. If a new standard allows modified retrospective adoption, prior periods are not fully restated, and the disclosures give the effect instead.

A change in accounting estimate is a better guess, such as a longer useful life. Prospective application means current and future periods only; nothing is restated.

$$\text{New charge} = \frac{\text{Carrying amount}}{\text{Remaining useful life}}$$

The correction of an error restates the prior periods affected and discloses the nature of the error. Do not confuse it with a change in estimate: an error is a mistake, not a better guess.

Exam tip Say it as “P-R-E-P”: Policy is Retrospective, Estimate is Prospective.

How do you measure growth without acquisitions and currency?

Strip out revenue from changes in scope (acquisitions and disposals) and currency effects, then compare with the prior year. The result is organic growth , the growth of the business you already had.

$$g_{org} = \frac{\text{Revenue}_1 - \text{Acquisitions} - \text{Currency effect}}{\text{Revenue}_0} - 1$$

Go deeper Why managers like to call costs non-recurring

Labeling a cost “non-recurring” invites investors to ignore it. Adjusted profit figures that exclude restructuring, impairment or litigation costs look better, and the same costs can show up year after year. Treat any adjusted measure as a claim to test: ask how often the item has appeared and whether it relates to running the business (see non-GAAP measures in reporting quality).