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Shedding more light on items reported directly in equity

Reporting Comprehensive Income

By Neel Foster and Natalie L. Hall

The FASB has released an exposure draft that would require an enterprise to display comprehensive income items reported directly in equity in a statement of financial performance. These statements of performance may be in either a one or two statement format but must be with the same prominence as other financial statements that constitute a full set of financial statements. Here is the background and explanation of this proposal.

Although many may not be familiar with the term "comprehensive income," they soon will be, because in June the FASB issued an exposure draft (ED) on reporting comprehensive income. But what is comprehensive income? We will answer that question along with how reporting comprehensive income would differ from current reporting and what factors led the FASB to consider requiring that comprehensive income be reported.

What Is Comprehensive Income?

Comprehensive income is not a new concept. It was first introduced and defined in 1980 in the FASB concepts statements as the change in equity (net assets) of a business enterprise during a period resulting from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. The roots of the definition are found in the all-inclusive income concept, wherein all revenues, expenses, gains, and losses recognized during the period are included in income.

In its early days, the SEC strongly favored the all-inclusive approach, but the Committee on Accounting Procedure of the American Institute of Accountants (now the AICPA) generally favored an approach that included in income of the period only the effects of normal recurring operations. Beginning in 1966, however, the AICPA's Accounting Principles Board (APB), the committee's successor, largely adopted the all-inclusive concept in several opinions that it issued.

The FASB continued what the APB began when it defined comprehensive income in a manner consistent with the all-inclusive income concept. However, while the Board generally has followed the all-inclusive income concept, it occasionally has made exceptions to it by requiring certain items to bypass the income statement and be taken directly to the equity section of the balance sheet. Those exceptions exist in FASB Statements No. 52, Foreign Currency Translation; No. 80, Accounting for Futures Contracts; No. 87, Employers' Accounting for Pensions; and No. 115, Accounting for Certain Investments in Debt and Equity Securities. Even though there are items in those standards that qualify as components of comprehensive income, they are not included in a statement that reports financial performance when they are formally recorded in financial statements. Accordingly, present-day net income is essentially a subset or subcomponent of comprehensive income.

How Would Reporting
Comprehensive Income Differ from Current Reporting?

The ED centers on issues of reporting and display rather than recognition and measurement; therefore, reporting comprehensive income would not require companies to gather any new financial information. All the necessary information is currently being collected. Any changes in present practice would be in the geography or presentation of information that companies already gather and provide to financial statement users; hence, first-year implementation costs should be minimal and subsequent costs may be nil.

The ED proposes that all components of comprehensive income be reported in one or two statements of financial performance. Thus, the presentation of comprehensive income may be in the form of a new financial statement, a second income statement to be added to the current set of financial statements, or it could take the form of an expanded traditional income statement.

If a second income statement is used, the traditional income statement would be left as it currently is. That type of treatment would help to maintain the continuity of present practice by continuing to report the traditional income statement with net income as the bottom line. The ED proposes that the net income be the starting point of the second statement and that it be added to other items of comprehensive income to arrive at total comprehensive income. The two-statement approach is illustrated in Example A.

On the other hand, an expansion of the traditional income statement to incorporate any additional items of comprehensive income would result in only one statement of financial performance. In that case, net income would become a subtotal within that statement while other items of comprehensive income would be shown below that subtotal to arrive at total comprehensive income as the bottom line of the single statement. The one-statement approach is illustrated in Example B.

Other Presentation Proposals

Reclassification Adjustments. Certain adjustments are necessary to avoid double counting for items displayed as part of net income for the current period that had been displayed as part of other comprehensive income in the current or earlier period. These are referred to in the ED as reclassification adjustments. An illustration is included in the examples. Holding
gains on securities amounting to $50,000 that arose during the period are reduced by $20,000 in arriving at other comprehensive income because such amount was realized and included in net income for the period. It should be noted that the total change is shown as two amounts. This "gross display" is required for reclassifications related to items of other comprehensive income other than minimum pension liability adjustments.

Per-Share Reporting. The ED would require display of a per-share amount for comprehensive income on the face of the statement of financial performance in which comprehensive income is reported. Such per-share
requirement is not applicable to nonpublic enterprises.

Tax Effects. Components of other comprehensive income may be shown individually net of related tax effects or before related tax effects with one amount shown for the aggregate income tax expense or benefit related to the total amount of other comprehensive income.

International Precedent for

Internationally, there is precedent for presenting a second statement of income. In 1992, the United Kingdom Accounting Standards Board (ASB) issued Financial Reporting Standard 3, Reporting Financial Performance (FRS 3), which introduced a statement of total recognized gains and losses as a second statement of income to supplement the profit and loss account (the U.K. equivalent to the U.S. income statement). The new statement is regarded as a primary statement and is presented with the same prominence as other primary statements. It reports a total of recognized gains and losses and the components of that total recognized in the period. The bottom line of that statement is comparable to what the FASB has defined as comprehensive income. FRS 3 also requires the presentation of a note of historical cost profits and losses, which is an abbreviated restatement of the profit and loss account to reflect, among other things, gains and losses realized in the period.

While the ASB has set the precedent in this area, its reasons for reporting comprehensive income do not exactly parallel those of the FASB, and the FASB has not reached all of the same reporting conclusions as the ASB. Some of the ASB's motivation to report what the FASB considers comprehensive income stems from a longstanding U.K. practice of permitting revaluation of real property in the accounts, which is not a practice in the U.S. However, because the ASB addressed and deliberated many of the issues now being addressed by the FASB, the FASB has tried to learn what it can from the ASB's efforts.

In addition to the ASB, the International Accounting Standards Committee (IASC) recently issued an exposure draft that, among other things, would require a separate statement to present items of income that are not conventionally included in the income statement. Examples of those items are revaluations of property, plant, and equipment, and exchange differences on translation of the financial statements of foreign entities. A separate statement might ease the ability to resolve, in an acceptable manner, some of the emerging issues involving items of income that the IASC anticipates addressing, such as the revaluation of financial instruments.

What Factors Led the FASB to
Consider Comprehensive Income?

The FASB received many requests from the analyst community to expand the reporting for items of comprehensive income. Analysts have expressed dissatisfaction not with what is reported in present-day statements of income, but rather with what is not reported in them. Specifically, their dissatisfaction is with the present practice of recording certain items of comprehensive income in equity.

The Association for Investment Management and Research (AIMR), one of the FASB's "sponsoring organizations" and one of the largest and most influential groups of users of financial statement information, specifically urged the Board to put into practice the concept of comprehensive income. The FASB rarely receives such a specific request from user groups. In its 1993 report, Financial Reporting in the 1990s and Beyond, the AIMR argued that comprehensive income "is needed for better and more useful financial reporting in several areas," including reporting the impact of changing fair values of marketable securities and all other nonowner changes in equity that presently are reported as equity adjustments. The AIMR report also emphasized its consistent support for the all-inclusive income statement format and indicated that "financial statement users need, in one place, all the data reporting an enterprise's economic activity, which they then may sort out to suit their own purposes."

Another important user group, the Robert Morris Associates (RMA), also favors the all-inclusive income concept, which the RMA's Accounting Policy Committee affirmed in its 1994 Summary of Positions Relating to Accounting Principles and Auditing Standards.

Support for reporting something akin to comprehensive income also has come from Michael H. Sutton, now chief accountant of the SEC, who co-authored a 1993 article in Financial Executive that urged the creation of a new statement to accommodate fair value measures in a balance sheet without having to report changes in those fair values in an income statement. The approach proposed would interpose a new statement between an income statement and a balance sheet and would allow the FASB to deal with conflicts in the objectives of reporting financial position as of a point in time and reporting traditional net income for a period of time.

The need to report comprehensive income has become more compelling over the years in light of the growth in the magnitude and importance of financial instruments and the increased reliability and relevance of using fair values to measure those instruments. Accordingly, reporting comprehensive income is necessarily related to the FASB's financial instruments project. In its June exposure draft on derivatives and hedging the Board concluded that all derivative instruments should be recognized and measured at fair value and noted its belief that all financial instruments should be carried in the statement of financial position at fair value when the conceptual and measurement issues are resolved.

Recognizing and measuring financial instruments at fair value will likely lead to debate among the Board's constituents. On one hand, some believe that recognizing those instruments and measuring them at fair value is essential if financial reporting for financial instruments is to be relevant. On the other hand, others resist taking those steps, largely because of the volatility that the resulting price changes might cause in income statements. Those differences in views have slowed the Board's progress in the past. A statement of comprehensive income is a vehicle whereby changes in the fair value of financial instruments could be shown in a statement of performance without affecting the traditional measure for net income.

Some Board members believe there is too much focus on net income and earnings per share. While they recognize those are statistics widely accepted and used extensively in the financial markets, they believe that if the components of comprehensive income become more transparent, analysts and other users of financial statements will be more likely to focus on those individual components in evaluating the quality of earnings and in assessing the likelihood that past reported income can be used to forecast future financial performance.

Key Dates

The proposed effective date of the ED is for fiscal years beginning after December 15, 1996, with earlier application

The Board encourages the active participation of all constituent groups in the comprehensive income project and welcomes their input on the issues raised in the ED. Comments are due by October 11, 1996. Public hearings are scheduled for November 15, 18, and 19. *

Neel Foster is a Board member at the Financial Accounting Standards Board, and Natalie L. Hall is a former postgraduate technical assistant at the
FASB and is currently a staff accountant at Ernst & Young LLP in Denver, Colorado.







The Financial Accounting Standards Board on June 20, 1996 issued two exposure drafts of considerable importance. The first, "Reporting Comprehensive Income," was a relatively short time in the making, but represents a major development--the introduction of a new financial statement and a new bottom line for business-type enterprises. The second, "Accounting for Derivative and Similar Financial Instruments and for Hedging Transactions," was a long time in the making and finally proposes the measurement aspects of accounting for derivatives. The two are very much interrelated because the proposed accounting for derivatives calls for the use in some instances of comprehensive income. The two statements have the same comment deadline of October 11, 1996 and will be the subjects of joint hearings scheduled for November 15, 18, and 19, 1996, (November 20, if necessary) at FASB offices in Norwalk, Connecticut. Because of the significance of the two proposals, The CPA Journal is presenting articles on both. Although the comment deadline is shortly after the mail date of the October issue to subscribers, FASB will be receptive to comments after the official deadline at least up to the date of the hearings. Readers are encouraged to become familiar with the proposals--they represent major changes to financial accounting. *

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