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The identification of nonrecurring or irregular items is not a mechanical process; it calls for the
exercise of judgment and involves both line items as well as the period-to-period behavior of
individual income statement items.
The Process of Identifying Nonrecurring Items
Careful analysis of past financial performance, aimed at removing the effects of nonrecurring items, is
a more formidable task than one might suspect. This task would be fairly simple if there were general
agreement on just what constitutes a nonrecurring item and if most nonrecurring items were
prominently displayed on the face of the income statement. However, this is not the case. Some
research suggests that fewer than one-fourth of nonrecurring items are likely to be found separately
disclosed in the income statement. 10 Providing guidance to aid in the location of the remaining threefourths
is a key goal of this chapter.
Identifying Nonrecurring Items: An Efficient Search Procedure
The search sequence outlined in Exhibit 3.4 locates a high cumulative percentage of material
nonrecurring items and does so in a cost-effective manner. Search cost, mainly analyst time, is an
important consideration because financial analysis is an economic activity that should be conducted in
an efficient manner. Further, time devoted to this task is not available for other tasks and, therefore,
there is an opportunity cost to consider. The discussion that follows is organized around this
recommended search sequence.
Nonrecurring Items in the Income Statement
An examination of the income statement, the first step in the search sequence, requires an
understanding of the design and content of contemporary income statements. This calls for a review of
the generally accepted accounting principles (GAAP) that determine the structure and content of the
income statement. Some nonrecurring items are prominently displayed on separate lines and readily
recognizable in the statement. Further, leads to other nonrecurring items, disclosed elsewhere, may be
discovered during this process. For example, a line item that summarizes items of other income and
expense may include an associated note reference detailing its contents. These notes should always be
reviewed (step 5 in the search sequence), because they often reveal a wide range of nonrecurring
items.
Exhibit 3.4 Efficient search sequence for nonrecurring items.