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Earning Power and Irregular Items

Earning power means the normal level of income to be obtained in the future. Earning
power differs from actual net income by the amount of irregular revenues, expenses, gains,
and losses.

Users are interested in earning power because it helps them derive an estimate of future
earnings without the “noise” of irregular items.

For users of financial statements to determine earning power or regular income, the
“irregular” items are separately identified on the income statement. Companies report two
types of “irregular” items:
1. Discontinued operations.
2. Extraordinary items.
These “irregular” items are reported net of income taxes.

Discontinued Operations
Discontinued operations refers to the disposal of a significant component of a business,
such as of a major class of customers, or an entire activity or operations in a geographical
area.

The income (loss) from discontinued operations consists of two parts:

 the income (loss) from operations up to the date of sale and
 the gain (loss) on disposal of the segment.

Note that the statement uses the caption “Income from continuing operations,” and adds a
new section “Discontinued operations.” The new section reports both the operating loss
and the loss on disposal net of applicable income taxes.

Extraordinary Items
Extraordinary items are events and transactions that are BOTH
(1) unusual in nature – abnormal and only incidentally related to the company’s
customary activities
(2)infrequent in occurrence - should not be reasonably expected to recur in the
foreseeable future.

Companies report extraordinary items net of taxes in a separate section of the income
statement, immediately below discontinued operations.
 2

When there is an extraordinary item to report, the company adds the caption “Income before
extraordinary item” immediately before the section for the extraordinary item.

If a transaction or
event meets ONLY
ONE OF THE
CRITERIA for an
extraordinary item,
the company reports
it under either “other
revenues and gains”
or “other expenses
and losses”.

The events and transactions of Denver Corporation for the year ending December 31, 2012,
resulted in the following data.
$
Cost of goods sold 2 600 000
Net sales 4 400 000
Interest expense 9 600
Dividend Income 5 600
Selling and administrative expenses 1 100 000
Income from operations of plastics division 70 000
Gain from disposal of plastics division 500 000
Loss from tornado disaster (extraordinary loss) 600 000

1. All items are before the applicable income tax rate of 30%.
2. The plastics division was sold on July 1.
3. All operating data for the plastics division have been segregated.

Required
Prepare an income statement for the year.