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During Fiscal 2006, inventory quantities were reduced. This reduction resulted in a liquidation of
LIFO inventory values, the effect of which decreased cost of goods sold by $4.0 million and
increased net income by $2.6 million or $0.08 per share. 22
Including the effects of the LIFO liquidations, Winnebago reported after-tax income from
continuing operations in 2006 of $68.2 million, but would have reported $65.6 million without the
LIFO liquidation, a 4% decrease. Given that the LIFO liquidation is nonrecurring, we would adjust
2006 earnings accordingly. Conceptually, the profit improvements resulting from LIFO liquidations
represent the realization of an undervalued asset, not sustainable core earnings. The effect is analogous
to the gain associated with the disposition of an undervalued investment, piece of equipment, or plot
of land.
Nonrecurring Items in the Income Tax Note
Income tax notes are among the more challenging of the disclosures found in annual reports.
However, they can be a rich source of information on nonrecurring items. Fortunately, one key
schedule found in the standard income tax note helps us to identify nonrecurring increases and
decreases in income tax expense. The schedule reconciles the actual tax expense or tax benefit with
the amount that would have resulted if all pretax results had been taxed at the statutory federal rate
(currently 35% in the United States). This disclosure for PepsiCo, Inc., is presented in Exhibit 3.17.
Exhibit 3.17 Reconciliation of statutory and actual tax rates: PepsiCo, Inc., years ended
December 31.
Source: PepsiCo, Inc., annual report, 2007, Note 5.
Notice that PepsiCo‟s effective tax rate was reduced in 2006 by 8.6% and in 2007 by 1.7% as a
result of a redetermination of taxes in prior years. The percentage effects are expressed in terms of the
ratio of the reduction in income tax expense to income from continuing operations before taxes. In
2007 PepsiCo‟s pretax income from continuing operations was $7,631 million, and its total tax
provision was $1,973 million. The 2007 effective tax rate, disclosed in Exhibit 3.17, is derived by
dividing the total tax provision by income from continuing operations before taxes: $1,973 divided by
$7,631 equals 25.9%. To determine the dollar, as opposed to percentage, tax savings from tax
settlements in 2007, multiply 1.7% times the 2007 pretax earnings: $7,631 million times .017 equals
$129.7 million. PepsiCo explained in its note: “In 2007, we recognized $129 million of non-cash tax