AVOIDING THE IMPLEMENTATION COSTS OF SFAS NO. 130
By Norman H. Godwin and
C. Wayne Alderman
CPAs and financial statement preparers faced the implementation of up to three new FASB standards in calendar year 1998: SFAS No. 130, Reporting Comprehensive Income; SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information; and SFAS No. 132, Employers' Disclosures About Pensions and Other Postretirement Benefits. The standard with the widest applicability is SFAS No. 130.
New standards such as these 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 informational benefit in financial statements. The overload and implementation costs stemming from SFAS No. 130 can be substantially eliminated through a simple accounting choice.
Reporting Comprehensive Income
SFAS No. 130 requires that all components of comprehensive income, which is defined as the total change in equity resulting from sources other than owner contributions and distributions, be reported in a prominent financial statement. The standard divides comprehensive income into two major components. The first component is net income as determined in the usual way--nothing new here. The second component is other comprehensive income. Under current accounting standards, other comprehensive income arises from three sources: foreign currency items, minimum pension liability adjustments, and unrealized holding gains and losses from investments in debt and equity securities.
These three sources of other comprehensive income came about in order to cut down on the volatility of net income by showing changes to certain assets and liabilities as adjustments to stockholders' equity. SFAS No. 130 requires that these changes now be prominently displayed in a calculation of comprehensive income.
To be considered prominently displayed, the calculation of comprehensive income can be added to the bottom of the current income statement, reported on a separate statement of comprehensive income, or reported within the statement of changes in stockholders' equity. FASB encourages the former two approaches.
Because many small firms neither sponsor defined benefit pension plans that could have a minimum pension liability adjustment nor engage in foreign business that would give rise to foreign currency items, the only aspect of SFAS No. 130 that may trigger the need for implementation is changes in investments in equity securities. However, as explained below, those investments can be structured so that a firm is no longer subject to SFAS No. 130 implementation.
The accounting treatment for equity investments is governed by SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Management can classify investments in equity securities as either trading securities or available-for-sale securities. Trading securities are those investments that management intends to sell in the near term. All other equity investments are classified as available-for-sale securities.
The main difference between trading and available-for-sale securities is the treatment of unrealized gains and losses. For trading securities, holding gains and losses are currently included in net income. In contrast, holding gains and losses for available-for-sale securities are excluded from net income and instead have been reported as a separate component of stockholders' equity. However, as stated above, SFAS No. 130 now requires that available-for-sale unrealized gains and losses be reported as a component of other comprehensive income. Thus, unrealized gains and losses from trading securities flow through net income while unrealized gains and losses from available-for-sale securities flow through other comprehensive income.
Implementation of SFAS No. 130 for entities that are subject to the standard only because of available-for-sale investments can be avoided by reclassifying the available-for-sale securities as trading securities. While the holding gains and losses would have to be reported in net income, there would be no requirement for reporting comprehensive income. Furthermore, this treatment is more conservative, by classifying such equity securities as trading securities rather than as available-for-sale securities. *
Norman H. Godwin, PhD, CPA, is an assistant professor of accountancy, and C. Wayne Alderman, PhD, CPA, the dean and South Trust Professor of Accountancy, both at Auburn University.
Douglas R. Carmichael, PhD, CFE, CPA Stan Ross Department of Accountancy,
Zicklin School of Business,
John F. Burke, CPA
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