– Components can be rearranged, subdivided, or tax effected, but the total must reconcile to net income of each period. – Discretionary expenses, components like equity in income (loss) of unconsolidated subsidiaries or affiliates should be segregated. – Components reported pretax must be removed along with their tax effects if reclassified apart from income from continuing operations.
CHAPTER
11
11-3
Earnings Persistence
• Earnings persistence is a key to effective equity analysis and valuation • Analyzing earnings persistence is a main analysis objective • Attributes of earnings persistence include:
Recasting and Adjusting
• Information for Recasting and Adjusting
– Income statement, including its subdivisions:
• Income from continuing operations • Income from discontinued operations • Extraordinary gains and losses • Cumulative effect of changes in accounting principles – Other financial statements and notes – Management’s Discussion and Analysis – Others: product-mix changes, technological innovations, work stoppages, and raw material constraints
Financial Statement Analysis
K R Subramanyam John J Wild
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
11-2
Equity Analysis and Valuation
11-7
Earnings Persistence
Recasting Earnings and Earnings Components – Income tax disclosures enable one to separate factors that either reduce or increase taxes such as:
• Deductions—tax credits, capital gains rates, tax-free income, lower foreign tax rates • Additions—additional foreign taxes, nontax-deductible expenses, and state and local taxes (net of federal tax benefit)
11-6
Earnings Persistence
Recasting Earnings and Earnings Components
• Aims at rearranging earnings components to provide a meaningful classification and relevant format for analysis.
Item Year 11 Year 10 Year 9 Year 8 Year 7 Year 6
13 19
145 144 16 17 102 20 104 162A 103 18 23 24 25 26 135 137 138 139
22
Net sales $ 6,204.1 Interest income 26.0 Total revenue $ 6,230.1 Costs and expenses: Cost of products sold (see Note 1 below) $ 3,727.1 Marketing and selling expenses (see Note 2 below) 760.8 Advertising (see Note 2 below) 195.4 Repairs and maintenance (see Note 1 below) 173.9 Administrative expenses 306.7 Research and development expenses 56.3 Stock price related incentive programs (see Note 3 below) 15.4 Foreign exchange adjustment 0.8 Other, net (see Note 3 below) (3.3) Depreciation (see Note 1 below) 194.5 Amortization of intangible and other assets (see Note 3 below) 14.1 Interest expense 116.2 Total costs and expenses $ 5,557.9 Earnings before equity in earnings of affiliates & min. interests $ 672.2 Equity in earnings of affiliates 2.4 Minority interests (7.2) Income before taxes $ 667.4 Income taxes at statutory rate* (226.9) Income from continuing operations $ 440.5 State taxes (net of federal tax benefit) (20.0) Investment tax credit — Nondeductible amortization of intangibles (4.0) Foreign earnings not taxed or taxed at other than statutory rate 2.0 Other: Tax effects (17.0) Alaska Native Corporation transaction — Divestitures, restructuring and unusual charges — Tax effect of divest., restructuring & unusual charges (Note 4) — (Continued on ings Persistence
Recasting Earnings and Earnings Components
Campbell Soup Company Recast Income Statements ($ mil.)
Item Year 11 Year 10 Year 9 Year 8 Year 7 Year 6
– – – – – – Stability Predictability Variability Trend Earnings management Accounting methods
Analyze
11-4
Earnings Persistence
Recasting and Adjusting • Two common methods to help assess earnings persistence:
$ 6,205.8 $ 5,672.1 $ 4,868.9 $ 4,490.4 $ 4,286.8 17.6 38.3 33.2 29.5 27.4 $ 6,223.4 $ 5,710.4 $ 4,902.1 $ 4,519.9 $ 4,314.2
$ 3,893.5 $ 3,651.8 $ 3,077.8 $ 2,897.8 $ 2,820.5 760.1 605.9 514.2 422.7 363.0 220.4 212.9 219.1 203.5 181.4 180.6 173.9 155.6 148.8 144.0 290.7 252.1 232.6 213.9 195.9 53.7 47.7 46.9 44.8 42.2
153A 28 14 144 162A 153A 15 145 21 102 103 104 136
Gain on sale of businesses in (Yr 8) and sub. in Yr 7 — Loss on sale of exercise equipment subsidiary, net of tax — LIFO liquidation gain (see Note 1 below) — Income before cumulative effect of accounting change$ 401.5 $ Cumulative effect of accounting change for income taxes — Net income as reported $ 401.5 $