“The 12-Month trailing EPS for Sample Fabrication Company as of 12/31/07 is $1.29. Sample stock trades at 42.50 per share as of 12/31/07. In the first two quarters of 2007, Sample reported an extraordinary loss of .22 per share. In the third quarter, the company reported a loss from the write-down of inventory of .04 per share. In the fourth quarter, Sample reported a gain of .08 per share from a change in accounting estimate when it increased the estimate of useful life of certain manufacturing equipment. Calculate underlying earnings.” The answer says Underlying Earnings=$1.29+$0.22+$0.04-$0.08=$1.47 Why do you add the losses and subtract the gain in this case?
EPS = 1.29 --------------------------- extraordinaly loss = 0.22 [addback] write down loss = 0.04 [addback] change in account estimate gain = 0.08 [subtract] all these are below the line iteams that are non-recurring and should be adjusted for (by adding back losses and subtracting out gains) to find the ‘underlying true economic recurring earnings’ UE = 1.29 + 0.22 + 0.04 - 0.08 = 1.47
I think this just wants you to normalize the earnings (take away events that are unusual or extraordinary) So if these things didnt happen this yr, what would have earnings been. You know earnings per share ended up being 1.29. If the write-down on inventory or extraordinary loss didnt happen, then you would have had an extra .26 cents of earnings. if you hadnt made favorable acct assumptions, then you wouldnt have that extra 8 cents in earnings. So you need to back that out.
Can you give me a list of things to memorize that are “below-the-line” items, so that in the heat of the moment on the exam, I can remember to back them out of net income?
Revenue - Operating expenses - Interest expense +/- other revenues and expenses +/- unusual OR infrequent items = Pretax Earning from Continuing Operations - Income Tax Expense = Income from Continuing Operations (the “Line”) +/- Income (loss) from Discontinued Operations (net of tax) +/- Extraordinary items (net of tax) (unusual AND infrequent) = Net income (original poster: JP_RL_CFA)
Note, this is for US GAAP assuming that it isn’t a financial firm. If it is IFRS, then extraordinary items do not exist and that income is part of earnings from continuing operations. If we are dealing with a financial firm, interest expense/revenue is considered part of operating income