Comprehensive Income
Comprehensive Income
“Comprehensive Income
is the change in equity (net assets) of an entity during a period from
transactions and other events and circumstances from non-owner sources. It
includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners. It includes net income and
other revenues, expenses, gains, and losses that under generally accepted
accounting principles are included in comprehensive income but excluded from
net income. Some parts of comprehensive income presently bypass the income
statement and are reported in a separate equity section of the balance
sheet." Comprehensive income consists of two main categories of net
income and other comprehensive income.
"Net income is an enterprise performance
measure favored by many financial statement users. However, several income
items are not shown on the income statement. Numerous groups of financial
statement users have called for revision of the number of income items that bypass
the income statement. The accumulated balances of these items are currently
reported in permanent equity accounts in the balance sheet, not on the income
statement. Although discussed in U.S. accounting literature for over twenty
years, the concept of a comprehensive income that captures these income items
first became popular outside the United States. The first accounting standard
addressing the issue was enacted in Europe. In 1992, the United Kingdom
Accounting Standards Board issued Financial Reporting Standard 3 that
introduced a statement of total recognized gains and losses as a Accounting
Standards Committee issued an exposure draft of a new income standard and
modified it in 1997. It is conceptually similar to recent U.S. comprehensive income
efforts."[i]
In December 1980, the
Financial Accounting Standards Board formally defined comprehensive income in
Concepts Statement No.6, as "the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources.” Description of comprehensive concept in Statement #130
covers wider rage of things than Statement #6. At the same time, FASB
identified in Statement No. 5 that comprehensive income and its components
should be reported as part of a full set of financial statements for a period.
This project was added to the Board's agenda in September 1995, at the urging
of financial statement users. In particular, the Association for Investment
Management and Research wanted FASB to expand the reporting for items of
comprehensive income.
In June 1997, Financial
Accounting Standards Board issued a new Statement of Financial Accounting
Standards #130 “Reporting Comprehensive Income.” This act was partially
triggered by the AIMR's (Association for Investment Management and Research)
call for more explicit Comprehensive Income. “The new figure will shine a
bright, embarrassing light on items that are now buried in shareholders’
equity, as well as items executives can use to even out bumpy earnings growth,”
says Bear Stearns accounting expert Pat McConnell. However even the new
statement did not cover what probably it should have covered. The new
statement coped only with reporting and presentation of the components of
comprehensive income, but it did not explain when they should be recognized and
how they should be measured.
Nowadays, the market is
very volatile and fair market values of the assets might change instantly. In
turn, change in fair market value leads to losses or gains in general value of
a company. If these effects find their reflections on the income statement,
it will mean very sudden high and low income reported by the company. The
reason why FASB adopted the concept of comprehensive income is to give
investors a full picture of the financial position of the company. Traditional
income statement does not include some of the items, but included in the equity
section of the balance sheet. These items are:
·
Unrealized gains
(losses) on available-for-sale securities
·
Change in foreign
currency exchange rates
·
Adjustments to
minimum pension liability
·
Hedging gains or
losses.
Unrealized gains or
losses on available-for-sale securities take place when the fair market value
of the securities is different than the one of the balance sheet. To be
consistent with accounting regulations, the company has to correct its assets’
value on the balance sheet. These gains or losses do not appear on the income
statement because their effect might mislead the investors, in terms of temporary
income of the company. On the other hand, the investors should be aware of
these gains or losses, and this is the reason for comprehensive income to
exist. The owner's equity section of the balance sheet accumulates these
changes in the value of the securities.
There are many
multinational companies right now on the market. These companies are subject
to gains or losses, the origin of which is change in exchange rates of the
currencies. These gains or losses do not happen due to routine operation of
the company and that is why they might mislead investors' opinion of the
company. The effect of these changes is included in the comprehensive income.
Underfunded pension
obligation necessitates an adjustment to the minimum liability in order to be
consistent with accounting regulations. It is not an obligation for the
company, but certainly influence future net incomes, and that is why it should
be included in comprehensive income.
The hedging gains or losses arise due to futures
contracts. A change is the market value of a futures contract that qualifies
as a hedge of an asset reported at fair value, unless earlier recognition of a
gain or loss in income is required because high correlation has not occurred
(SFAS #115).
There are three ways to present
comprehensive income:
·
A separate income
statement is prepared
·
A comprehensive
income is combined with income statement
·
A comprehensive
income is represented as a part of the statement of stockholder’s equity
For some of the companies implementation of
reporting comprehensive income had "negative" or positive effect on
"bottom-line income." For instance, General Motor's had
negative impact (-64.1%) and Citibank
had positive (18.3%). Out of 24 major corporations, 15 reported a lower
comprehensive income than their net income, and only nine of them displayed an
increase in comprehensive income in comparison with net income.
|
General Motors
|
-64.10%
|
Wal-mart
|
-15.00%
|
Coca-Cola
|
-14.90%
|
Procter & Gamble
|
-11.70%
|
Chase-Manhatan
|
-11.50%
|
Ford Motor
|
-10.80%
|
IBM
|
-9.70%
|
Johnson & Johnson
|
-9.40%
|
Texaco
|
-7.70%
|
Eli Lilly
|
-6.30%
|
-3.90%
|
Exxon
|
-2.80%
|
Mobil
|
-1.60%
|
Dupont
|
-0.60%
|
Merck
|
-0.30%
|
Chrysler
|
0
|
Hewlett Packard
|
0
|
Disney
|
0.10%
|
BankAmerica
|
0.60%
|
Microsoft
|
0.70%
|
AT&T
|
Intel
|
1.40%
|
NationsBank
|
2.90%
|
Pepsico
|
3.50%
|
General Electric
|
7.60%
|
Citibank
|
18.30%
|
Such new standards are often a source of
frustration, especially to smaller, nonpublic entities and their CPAs. This
frustration, often called standards-overload, arises both from the frequent
issuance of new and often complicated standards and from the lack of perceived
information benefit in financial statements. The overload and implementation
costs stemming form SFAS #130 can be substantially eliminated through
reclassification of the available-for-sale securities as trading securities,
and this is what small private corporations usually do.
Regarding reporting
financial performance, international standards say the following:
·
IAS 1 requires presentation
of a statement showing changes in equity. Various formats are allowed:
1)
The statement
shows (a) each item of income and expense, gain or loss, which, as required by
other IASC Standards, is recognized directly in equity, and the total of these
items, certain foreign currency translation gains and losses (IAS 21, The
Effects of Changes in Foreign Exchange Rates), and changes in fair values of
financial instruments (IAS 39, Financial Instruments: Recognition and
Measurement)) and (b) net profit or loss for the period, but no total of (a)
and (b). Owners’ investments and withdrawals of capital and other movements in
retained earnings and equity capital are shown in the notes.
2)
Same as above,
but with a total of (a) and (b) (sometimes called “comprehensive income”).
Again, owners’ investments and withdrawals of capital and other movements in
retained earnings and equity capital. An example of this would be the
traditional multicolumn statement of changes in shareholders’ equity.
Bibliography
[i] The impact of reporting
comprehensive income, Ohio CPA Journal; Columbus; Jan-Mar 1999; Richard J
Schmidt.
Comprehensive income reporting and analysts’
valuation judgements, Journal of Accounting Research; Chicago; D Eric Hirst;
Patrick E Hopkins.
How companies are complying with the
comprehensive income disclosure requirements; Ohio CPA Journal; Columbus;
Jan-Mar 1999; Linda Campbell; Dean Crawford; Diana R Ranz.
Reporting Comprehensive Income; The Secured
Lender; New York; Mar/Apr 1998; Eran Echreiber.
Discussion if comprehensive income reporting and
analysts’ valuation judgements; Journal of Accounting Research; Chicago;
1998; Marlys Gascho Lipe;
Avoiding the implementation costs of SFAS #130;
The CPA Journal; New York; Jun 1999; Norman H Godwin; C Wayne Alderman;
Disclosure of comprehensive income may be
confusing; Texas Banking; Austin; Oct 1996; Harrison, John S; Lynch,
Chris;
The call for reporting comprehensive income;
Financial Analysts; Charlottesville; Mar/Apr 1996; Cope, Anthony T;
Johnson, L Todd; Reither.
Comprehensive income; Management Accounting;
New York; Dec 1995; Bisgay, Louis.