October 2001
Comprehensive Income Disclosures
By Sak Bhamornsiri and Casper Wiggins
In June 1997, FASB issued SFAS 130, Reporting Comprehensive Income, which requires business enterprises to report comprehensive income and its elements as part of their general-purpose financial statements. For many companies, comprehensive income differs substantially from reported net income, and income-based ratios or performance measures based thereon may vary dramatically as well. Comprehensive income is a broader concept than net income because it includes all changes in equity during the year except those resulting from transactions with shareholders. The difference between net income and comprehensive income is known as other comprehensive income (OCI).
An evaluation of comprehensive income disclosures and their potential impact on financial performance measures for S&P 100 companies during fiscal years 1997–1999 indicates that the majority of companies report comprehensive income as part of their stockholders’ equity disclosures. On average, comprehensive income differs significantly from net income for most companies, varying by as much as 12% (in absolute terms) over the three-year period.
In each year studied, the number of companies negatively affected by OCI was significantly greater than those positively affected. Consequently, the impact on key financial measures such as earnings per share (EPS) was also significant. If analysts were to incorporate OCI into their evaluations of a company’s performance, they might reach different conclusions from those based on net income alone. Accounting policymakers should consider requiring that comprehensive income be prominently displayed on the statement of operations or on a separate statement of comprehensive income, rather than be buried in the statement of stockholders’ equity.
Approaches to Measuring Income
Two approaches to measuring income are commonly discussed in the accounting literature: the transaction approach and the capital maintenance approach. Under the transaction approach, income is calculated by analyzing the effects of revenue and expense transactions during a period. Any change in the value of the enterprise that is not a result of a transaction is not reflected in the enterprise’s net income. Income from continuing operations under current GAAP is based on the transaction approach.
Under the capital maintenance approach, however, net income is defined as the difference between the net assets (assets minus liabilities) at the beginning of a period and net assets at the end of the period, excluding owners’ contributions and distributions during the period. The capital maintenance approach captures all changes in the value of the enterprise during a period, regardless of whether the change resulted from a transaction.
Comprehensive income reflects the capital maintenance approach. FASB identified comprehensive income as early as 1980 in Statement of Financial Accounting Concepts 3, Elements of Financial Statements of Business Enterprises. FASB regarded comprehensive income as one of the 10 elements of financial statements relevant in measuring the performance and financial condition of a business enterprise.
Reasons for comprehensive income disclosure. According to FASB, some users of financial statements expressed concern over the number of comprehensive income items that companies dumped into the equity section of the balance sheet in order to bypass the income statement. Other financial statement users criticized the lack of uniformity in presenting comprehensive income information in the financial statements. These users urged FASB to establish a set of standards for the disclosure of comprehensive income items.
The survey. The authors examined the financial statements of S&P 100 companies for fiscal years 1997 through 1999. The majority of these firms are in the manufacturing sector (55%). Another 40% of the sample companies are in transportation, retail trade, finance, and services. The remaining 5% are in mining and construction. The 1999 average revenues for the sample was $22.9 billion, ranging from a high of $185 billion to a low of $748 million, with a standard deviation of $34.4 billion. See Exhibit 1 for details.
Comprehensive Income Disclosures
SFAS 130 does not change the reporting requirements for net income under current GAAP. Rather, it prescribes additional information about OCI that must be disclosed. Comprehensive income of an enterprise is the sum of the enterprise’s net income and OCI. The three components of OCI are unrealized gains or losses on available for sale securities, foreign currency translation adjustments, and minimum pension liabilities.
An enterprise may choose one of the following formats for reporting comprehensive income:
The majority (76) of the companies surveyed reported comprehensive income as a part of the statement of stockholders’ equity (See Exhibit 2). Of these, nine companies also changed the title of the stockholders’ equity statement to include the term “comprehensive income.” The second most frequent method of disclosure (15) was a separate statement of comprehensive income. Only three companies disclosed comprehensive income on the face of the income statement. Of the 100 companies, five failed to include comprehensive income disclosures, and two of these explained that net income and comprehensive income were the same in the years reported. The other three made no disclosures or disclaimers.
There were no separate disclosures for comprehensive income in the notes to the financial statements for any of the companies. Comprehensive income was often referred to in notes regarding pensions, investments, and other related areas.
Campbell, et al. (The Ohio CPA Journal, January/March, 1999) examined the 1997 financial statements of 73 companies that adopted SFAS 130 early. They found that early adopters with negative OCI were more likely to disclose comprehensive income in the statement of stockholders’ equity, whereas firms with positive OCI were more likely to report comprehensive income in their income statement or in a separate statement of comprehensive income.
A significant portion of the firms that reported comprehensive income in 1999 presented it in the stockholders’ equity section, regardless of whether OCI was negative or positive. Exhibit 3 shows that approximately 3–5% of firms in both the negative OCI and the positive OCI groups chose to report comprehensive income on the income statement; 15–16% of each group chose the separate statement format; and 79–82% of each group chose the stockholders’ equity format. Exhibit 3 reports percentages consistent with the overall percentages presented in Exhibit 2. There is no evidence of the manipulation of comprehensive income disclosures based on its positive or negative character.
Components of OCI
Exhibit 4 presents the three components of OCI as reported by the surveyed companies for each of the three years. Foreign currency translation adjustments were reported by approximately 80% of the sample companies each year, and were far more commonly reported than the other two components. Approximately 30–35% reported minimum pension liabilities and 45–55% reported unrealized holding gain or loss components. Foreign currency translation adjustments, however, represent the largest OCI component in monetary terms.
Exhibit 4 also indicates that for all three periods, the number of companies that were negatively affected by OCI was significantly greater than the number positively affected by OCI. The average OCI was –$180 million in 1997 but dropped to –$29 million in 1999. The nature of OCI’s components could make it volatile and reporting on it could also lead to more careful management, making the period of study too brief to draw conclusions.
Financial Ratio Impacts
Exhibit 5 presents an analysis of the percentage change in EPS if comprehensive income is used instead of reported net income. The EPS of 60 companies would be negatively affected by the inclusion of OCI, whereas only 35 companies would be positively affected. At a 10% materiality threshold, 46 companies were materially affected by OCI. The impact on EPS can be explosive: Some companies’ EPS would change by more than 100% (Exhibit 6).
Changes in Users’ Perspectives
Investors and creditors might at some point shift their focus toward comprehensive income and away from net income. The investment community could also move conceptually toward the capital maintenance approach and away from the transaction approach. Although there is not currently enough evidence to indicate whether financial statement users would consider OCI in making their investment or credit decisions, FASB has sent a clear signal in SFAS 130 that a broader income concept should play an expanding role in future financial decisions.
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