In: Accounting
Excerpts from the statements of comprehensive income for Wild Adventures Ltd. for the years 20X2 through 20X4 are as follows:
1. Wild has experienced volatile earnings over the three year period shown. Do you expect this to continue? Why or why not?
2. Net earnings increased from a loss of $14 million in 20X3 to a profit of $60 million in 20X4, a very substantial increase. Suppose the company’s common share price increased only approximately 20% during the same period. Why might this be the case? Relate the 20% increase in share price to the components of net income.
3. Would you expect net income in 20X5 to be more or less than the amount reported in 20X4? More specifically, assuming no new unusual, nonrecurring items, what amount would you estimate net income to be in 20X5?
1.
The up and down pattern of earnings is not caused by the company’s continuing operations, but rather by the several special items reported after income from continuing operations. If these special items are not recurring, earnings for the company should become more stable, similar to the income from continuing operations line.
2.
The large increase is caused primarily by items that are not likely to be recurring since they were more significant in those years than normally. The loss from the writedown in inventory of that large amount in 20x3 is not expected to recur even though there may be insignificant writedowns in some years. The foreign exchange gain is harder to predict since the Canadian dollar has had significant fluctuations. The stock market is most likely responding to the change in income from continuing operations rather than to the “bottom line” net income amount. Income from continuing operations increased 40% (a $15 million increase divided by $35 million), which is a higher percentage than the increase in share price. This may be because shareholders saw the foreign currency gain as something that may become a loss.
3.
In general, the foreign exchange gain and inventory loss will be separately reported on the income statement because they are not expected to recur or they are a larger amount than usual. Assuming this is the case, income from continuing operations is the only amount expected to be recurring. Lacking any additional information, a rough estimate of earnings for 20x5 would be $70 million before taxes, which is a 40% increase in 20x4 earnings from continuing operations.
The point is that income from continuing operations becomes the starting point for estimating future earnings, not reported earnings that include the non-recurring items.
The point is that income from continuing operations becomes the starting point for estimating future earnings, not reported earnings that include the non-recurring items.