Lecture 3 Core and unusual items Items with no predictive relevance Three considerations for forecasting: The time series of a particular item Our understanding of the nature of the item Availability of information in the annual report, including (for operating items) the segmental report Comparison distorting

Operating items Unusual items often footnote items to “other operating revenues” “other operating expenses” Net positive and negative items of the same nature “exchange rate gains” and “exchange rate losses” Classify as unusual only if the distribution of the item among segments is known

Operating items Assets/liabilities at historical cost Exchange rate gains and losses Unusual items Restructuring costs Core items Gains and losses on sales of assets and operations Write-downs of assets and reversals of write-downs

Operating items Assets measured at fair value Investment property (Land and buildings used to earn rentals and/or capital appreciation) Gains and losses on sale of assets Revaluations Unusual items Forecasts: fair value x forecasted rate of inflation

Financial items Assets / liabilities at cost Gains and losses on sale Write-downs and reversals of write-downs Core items Exchange rate gains and losses Unusual items

Financial items Assets at fair value Gains and losses on sale Revaluations (recognised in the income statement) Core items

Discontinued operations Low predictive relevance, but Accounting ratios would be distorted, unless the corresponding assets were not also classified as ”unusual” Core items Segmental report used to handle the issue

Majority and minority shareholders Equity Shareholders’ equity (attributable to the shareholders of the parent company) Minority interest (attributable to the minority shareholders of the subsidiaries) Net income Net income attributable to majority shareholders Minority income

Changes in shareholders’ equity Beginning shareholders’ equity Net dividends (to maj. shareholders) + Net income (of maj. shareholders) Dirty surplus (of maj. shareholders) = Ending shareholders’ equity

Net dividends Net dividends = Dividends (to shareholders of the parent) + Share repurchases - New issues of shares ± Other shareholder related transactions e.g. equity component of convertible bonds conversion of convertible bonds

Dirty surplus Dirty surplus = deviations from the CSR (clean surplus relationship) The valuation models are based on CSR, hence we need an income measure consistent with the CSR

Comprehensive income Comprehensive income = Net income ± Dirty surplus Change in shareholders’ equity according to the CSR Beginning shareholders’ equity Net dividends + Comprehensive income = Ending shareholders’ equity

Examples of dirty surplus “total change in net asset value reported directly against equity, excluding transactions involving company shareholders” Translation differences Exchange rate gains and losses on net assets of foreign subsidiaries (Note: exchange rate gains and losses on claims and liabilities in foreign currencies are recognized in the income statement – not dirty surplus) Changes in fair value of “available for sale financial assets” Value changes recognized directly in equity

Examples of dirty surplus Changes in accounting principles Recognized “retrospectively” Opening balance of shareholders’ equity (for the oldest comparative year) is adjusted Special problem Implementation of IAS/IFRS in 2005

Change in minority interest Beginning minority interest Net dividends to minority owners + Minority income Dirty surplus (attributable to minority owners) = Ending minority interest