Question

Earnings may be classified as either recurring or nonrecurring. In your own words please discuss how these classifications differ. Your discussion should include their importance relative to each other in valuing a company. Also please describe permanent, value irrelevant and transitory earnings according to the above-mentioned recurring and nonrecurring framework.

Answer 1

Earnings are the net cash flows derived from doing an activity. If the activity is able to continue in the future and derive earnings out of the same activity , it is known as recurring earnings. If the activity is one time event and is not performed on consistent basis , but still some earnings is derived from the (extra ordinary ) event , it is known as non recurring earnings.  

For eg , a mobile company is generating earnings from selling of mobile , it would be considered as recurring earnings . But when such company organises an event for which ticket entry charge is 1000 rs , and they made some earnings out of the event organised , it would be non recurring earnings .

1. For a going concern company each dollar of the permanent component is equal to 1/r dollar of company value, where r is the cost of capital.

2. Transitory component. - It has a dollar- for-dollar effect on company value (there is no discounting as they are non recurring). The concept of economic income includes both permanent and transitory components.

3. Value irrelevant component. Value irrelevant components have no economic content .They are accounting distortions. They arise from the imperfections in accounting. Value irrelevant components have zero effect on company value.