The Association Between Nonrecurring Items and Future Cash Flows and Earnings

• In Event: Financial Accounting & Reporting and Strategic & Emerging Issues

Abstract

Financial statement users often adjust reported net income numbers for nonrecurring items to obtain a more accurate assessment of future earnings ability. Users usually make the adjustments on an ad hoc, inconsistent basis. In contrast, in 2002, Standard & Poor’s (S&P) introduced Core Earnings as a proprietary, uniform earnings metric based on six consistent adjustments to GAAP earnings for nonrecurring items. This study categorizes the six nonrecurring items as discretionary or non-discretionary, and examines the relationship between these nonrecurring items and future operating cash flows and income before extraordinary items. Sample firms have Core Earnings and cash flows/earnings for each of the next 3 years, and cross-sectional regressions are estimated to determine the relationship between each discretionary or non-discretionary adjustment and the dependent variables. We find that goodwill impairment charges, settlements and litigation proceeds, and gains/losses from asset sales (discretionary adjustments) are negatively associated with cash flows and earnings, while reversals of prior-year charges (non-discretionary adjustment) are positively associated with cash flows and earnings.

Authors

• Mark C. Dawkins, University of Georgia

• Matthew M. Wieland, Indiana University–Purdue University Indianapolis

• Michael T Dugan, University of Southern Mississippi