Articulated Statements

Currently a complete set of financial statements prepared in conformity with GAAP consists of a status report and several activity reports. The activity reports provide information about transactions and events that change the value of assets and liabilities. The interrelationship of these reports is sometimes referred to as articulation.

Historically, financial statements prepared in conformity with GAAP have been fundamentally interrelated, and the activity reports explained all changes in net assets other than those resulting from transactions with owners. in the absence of transactions with owners acting as owners, the net income or loss of the period equalled the change in net assets.

However, as a result of certain decisions of the FASB, an additional factor is added to financial statements not currently explained in the activity reports. This is referred to broadly as nonowner changes in equity, that result from events and circumstances other than changes in investments by owners or distributions to them.

SFAS 12: The First Step

The first step in the new development was taken in SFAS 12, Accounting for Certain Marketable Securities. " Marketable equity securities other than those accounted for by the equity method are classified as either current or non-current assets and reported at the lower of cost or market. If the aggregate market value is less than the aggregate cost of each portfolio, the change in value is recognized through the use of a contra asset valuation account. Certain changes in the current portfolio of marketable equity securities are recognized in the income statement. Changes in the value of the non-current portfolio, however, are reported as a component of stockholders' equity.

The exposure draft leading to SFAS 12 would have required that all changes in the carrying amount of the marketable equity securities portfolio be reflected in income. It made no distinction between the current or non-current classifications of such securities. Some respondents to the exposure draft argued against such treatment on the basis that including fluctuations in the value of securities held as long-term investments in income would cause distortions that would not be understood by investors. Although the FASB stated that it did not necessarily accept the respondents' reasoning, it did proceed to require those changes to be reported in equity, and it recognized the need for authoritative clarification concerning the recognition of unrealized gains and losses on long-term assets.

The FASB's decision was not unanimous. one member wanted the portfolio of current securities to be carried at market. Another believed that all marketable equity securities should be carried at market value. Others have also criticized SFAS 12 for not requiring such securities to be reported at market, and some have argued that all such value changes should be a part of income. The decision made in SFAS 12 can be defended in retrospect by observing that the FASB found a way to distinguish among value changes based on their probability of imminent realization and thus their impact on cash flows. The value changes of the current portfolio are reported in the income statement, while those of the non- current portfolio are not because they might be realized in a remote future time.

SFAS 52: Economic Effects or Mechanical Adjustments?

SFAS 52, Foreign Currency Translation," introduces another nonowner change to the equity, section of the balance sheet, but, in the intervening years following SFAS 12, the FASB had issued three Statements of Financial Accounting Concepts SFACS) which prepared a theoretical foundation for this treatment. SFAC 3, Elements of Financial Statements of Business Enterprises, " and its successor SFAC 6, Elements of Financial Statements, " recognize that some nonowner events or circumstances may change net assets without having an impact on the income statement.

The FASB reports that members who assented to SFAS 52 were of two views regarding the rationale for including the cumulative translation adjustment in equity rather than reporting the change in income. One view supports reporting of the translation adjustment as a change in equity because a change in the exchange rate between the dollar and the other currency produces a change in the dollar equivalent of the net investment, but there is no change in the net assets of the other entity measured in its functional currency. By reporting the economic effects of the change in exchange rate in the owners' equity section of the statement of financial position, these effects are treated as unrealized.

The other view holds that the translation adjustment is merely a mechanical byproduct of the translation process and thus represents a restatement of previously reported equity. The FASB did not settle on which view should be accepted.

If the first view is accepted, the FASB may be viewed as requiring the economic effect of two unrealized value changes (lower of cost or market in the non-current investment portfolio and foreign currency translation adjustments) to be reported in equity. If the second view is adopted, then the FASB has required two disparate events to be reported in a similar fashion. Both perspectives support the contention that the FASB has set the stage for more meaningful distinctions than were possible in the past. The next development in financial accounting standards requiring recognition in equity of special nonowner transactions applied to the insurance industry, an industry exempted from the provisions of SFAS 12 due to its specialized practices.

SFASs 60 and 80: Extending the Principles of SFAS 12

SFAS 60, Accounting and Reporting by Insurance Enterprises," expands the treatment of investments initiated in SFAS 12 and requires certain unrealized gains and losses to be reported as a component of equity. Common stock, nonredeemable preferred stock, and bonds-if the insurance enterprise is a trader in bonds having no intention of holding them to maturity-are reported at market value and the associated unrealized gains and losses are reported as a component of equity. Although the types of securities to be treated in that manner are broader than those covered by SFAS 12 and although the securities are reported at market rather than the lower of cost or market, the treatment of the unrealized gains and losses parallels that of the unrealized losses and subsequent recoveries accorded non-current marketable equity securities under SFAS 12.

SFAS 80, Accounting for Futures Contracts," also addresses an item to be included as a component of equity, albeit in narrowly defined circumstances. As a general rule, the statement requires changes in the market value of a futures contract to be recognized in income. If an enterprise (such as an insurance company) reports assets at fair value and includes the unrealized changes in value in equity pending sale or other disposition, then unrealized gains and losses on the futures contract designated as a hedge of such assets should also be reported as a separate component of equity. This treatment is a logical consequence of hedging an asset reported at fair value if the changes in that asset's value are not reflected in income.

SFAS 87: Reporting Unrecognized Pension Costs

The latest step in the FASB's development of nonowner transactions that directly have an impact on equity occurs in SFAS 87, "Employers' Accounting for Pensions." This statement requires that any excess of additional liability required to be recognized over unrecognized prior service cost be reported as a separate component of equity. The FASB states that such a component would represent a net loss not yet recognized as net periodic pension cost. On each balance sheet date, the additional liability is redetermined and the related intangible asset (unrecognized prior service cost) and the corresponding separate component of equity are adjusted as necessary.

Similarities of Items Included in Equity as Nonowner Changes

SFAC 5 explains how these components of equity fit into its scheme of financial accounting and reporting. The plan intends that a full set of financial statements would include: balance sheet, income statement, cash flows statement, statement of comprehensive income, and statement of investments by and distributions to owners during the period. The addition of the last two activity reports to those currently required by GAAP ensure that all changes in net assets during a period would be explained in one or more activity reports.

The FASB explains that the statement of comprehensive income would include earnings from the statement of earnings (income statement in a slightly revised form), and the changes in the separate components of equity other than those occurring from investments by or distributions to owners. The latter items fall into two classes: effects of certain accounting adjustments, and certain other changes in net assets which are principally certain holding gains and losses.

The FASB states that users of financial statements will benefit if those statements convey information that helps them to assess various factors including the entity's liquidity, financial flexibility, profitability, and risk. The FASB suggests that perceptions regarding realizability and volatility may help explain special recognition rules such as those associated with these nonowner changes in equity.

Are users of financial statements ready for a statement of comprehensive income? it is the logical way in which to return to full articulation of the financial statements.