In a question the gain on sale of new business and restructuring charges were given and earnings adjusted for nonrecurring items was to be calculated. So I’ll subtract gain on sale and restructuring charges, right? and what about sale of new product launched? will it be included in the adjusted earnings also?
Hey, Sorry about this question again. When I reread it I didn’t understand the reason behind adding an expense when we should subtract it.
So why do we add restructuring charges aren’t they expenses and don’t we deduct expenses?
Another question was from Residual Income Q23
Amersheen announced a significant restructuring charge of 2 million, that would be reported as part of operating earnings in Income statement. The correct way to treat restructuring charge would be?
upward adjustment to book value
upward adjustment to cost of equity
exclude it from the estimate of net income
C is correct
The answer says that it is a non-recurring item and not indicative of future earnings. In applying a residual income, it is important to develop a forecast of future residual income based on recurring items. Using the net income to model subsequent future earnings, without adjustment for restructuring charge would understate the firm’s future earnings. By upward adjusting the firm’s net income by adding the restructuring charge to reflect the fact that the charge is nonrecurring, future earnings will be more accurate forecasted.
Isn’t it conflicting. The answer says to exclude but in the description it says to include in the net income. Is treating restructuring charge in residual income different?
It is not conflicting. The reported net income is:
reported net income = “recurring net income” - restructuring charge
so by upward adjusting reported net income you get
reported net income + restructuring charge = “recurring net income”
which you then use to estimate future net income. Thus by adding the restructuring charge to reported net income you have eliminated (excluded) the restructuring charge from your estimates of future net income.
You are correct that recurring net income does not include a restructuring charge, but reported net income does.
From the question:
“Amersheen announced a significant restructuring charge of 2 million, that would be reported as part of operating earnings in Income statement.”
Meaning the restructuring charge is part of operating earnings which in turn is part of reported net income. So if you want to base your estimate of future net income on currently reported net income you need to adjust by adding the restructuring charge to currently reported net income to get to recurring net income.
But you said so yourself that recurring net income does not have restructuring charges because it is non-recurring. why do we add restructuring charges to reported net income to get recurring net income?
We add restructuring charges cause its a one time charge. In other words, this charge will not occur again unless a company plans to restructure again. We get a “normalized” net income by adding these charges. By normalized I mean “a fair net income” or “the true net income” from its daily operations.