632598256894

The construction of an SEB worksheet always requires the exercise of judgment. Materiality
judgments are avoided by simply recording all nonrecurring items without regard to their materiality.
However, the classification of items as nonrecurring, as well as on occasion their measurement, calls
for varying degrees of judgment. Two examples of Pfizer items that required the exercise of judgment,
in terms of either classification or measurement, are discussed next.
Acquired In-Process R&D
For a pharmaceutical firm like Pfizer, research and development—both internal and acquired—is a
core component of operations. Consequently, some users of financial statements treat acquired inprocess
R&D as a component of R&D expense. Its irregularity, however, is a good reason to separate
it from measures of sustainable earnings. Note that beginning in 2009, acquired in-process R&D will
be capitalized as an identifiable intangible asset and will be expensed only when the R&D efforts are
completed or abandoned. 39
The Tax Rate Assumption
The tax rate used in the Pfizer worksheet was a combined (federal, state, and foreign) 16 percent. This
is the three-year average effective tax rate for the company based on the recurring portions of the
income tax provision, as disclosed in the income tax note in Exhibit 3.27. The tax rate scales the
numbers in the worksheet to their after-tax amounts. The goal should be a rate that is a reasonable
representation of this combined rate and reflects the effects of a company‟s geographic choices. Pfizer
clearly enjoys tax benefits from its overseas operations.
Summary
An estimation of the sustainable portion of earnings should be the centerpiece of analyzing business
earnings. This task has become a far greater challenge over the past decade as nonrecurring items have
increased with corporate reorganizations and associated activities and with enhanced levels of
disclosure. Some of the labels attached to these producers of nonrecurring items are restructuring,
rightsizing, downsizing, reengineering, redeployment, repositioning, reorganizing, rationalizing, and
realignment. The following are some key points to consider:
• An earnings series from which nonrecurring items have been purged is essential in order to
both evaluate current trends in operating performance and make projections of future results.
• The identification and measurement of nonrecurring items will typically require the
exercise of judgment.
• There are no agreed-upon definitions of nonrecurring items as part of GAAP. Moreover,
various labels are used beyond the term nonrecurring, including special, unusual, non-operating,
and noncore.