|Randall W. Luecke , CPA, CMA is the vice-president-administration and treasurer of International Approval Services, Clevland. IAS is division of the Canadian Standards Association. David T. Meeting , CPA, DBA, is associate professor of accounting at Cleveland State University.|
The pendulum of income reporting is again changing direction. At different times over the years, businesses have used two major income reporting concepts. Under the current operating performance concept , extraordinary and nonrecurring gains and losses are excluded from income; because those gains and losses are taken directly to equity and bypass the income statement, this is sometimes called the "dirty surplus" method. Under the all-inclusive (comprehensive) concept , all items, including extraordinary and nonrecurring gains and losses, go to the income statement; the result is a "clean surplus," since all gains and losses are reported in the income statement.
The AICPA Accounting Principles Board moved toward the all-inclusive income concept in 1966 when it issued Opinion no. 9, Reporting the Results of Operations , and later reaffirmed this concept in Opinions nos. 20, Accounting Changes , and 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions . The FASB followed the all-inclusive concept, except when changes in certain assets and liabilities were not reported in the income statement but, rather, were included as a separate component of equity. Pronouncements with such exceptions are FASB Statements nos. 52, Foreign Currency Translations , 80, Accounting for Futures Contracts , 87, Employers' Accounting for Pensions , and 115, Accounting for Certain Investments in Debt and Equity Securities .
Starting with Statement no. 12, Accounting for Certain Marketable Securities, in 1975, the FASB used a hybrid of the operating performance and the all-inclusive concepts. More recently, in Statement no. 130, Reporting Comprehensive Income, it moved closer to the all-inclusive income determination method. This article explains this and other important aspects of Statement no. 130 and offers implementation guidance companies can use as they begin to comply with the statement.
WHAT IS COMPREHENSIVE INCOME?
In Concepts Statement no. 5, Recognition and Measurement in Financial Statements of Business Enterprises , the FASB said a full set of financial statements for a period should show
- Financial position at the end of the period.
- Earnings (net income).
- Comprehensive income (total nonowner changes in equity).
- Cash flows during the period.
- Investments by and distributions to owners during the period.
FASB Concepts Statement no. 6, Elements of Financial Statements , went on to define comprehensive income as the change during a period in an enterprise's equity from transactions and other events and circumstances from nonowner sources, including all changes in equity except those resulting from investments by owners and distributions to owners. Although the FASB generally has followed the all-inclusive income concept, it occasionally has made specific exceptions by requiring that companies not report certain changes in assets and liabilities in a statement reporting results of operations but, instead, include them in balances within a separate component of equity in a statement of financial position. These exceptions are summarized in exhibit 1, page 47.
...AND WHY REPORT IT?
A business reports comprehensive income to reflect all changes in its equity that result from recognized transactions and other economic events of the period-other than transactions with owners in their capacity as owners. Historically, companies displayed some of these changes in a statement that reported the results of operations, while other changes were included directly in balances within a separate component of equity in a statement of financial position.
Statement no. 130 requires that all items meeting the definition of components of comprehensive income be reported in a financial statement for the period in which they are recognized. Thus, Statement no. 130 amends the accounting standards listed in exhibit 1 to require that changes in the balances of items that-under those statements-had been reported directly in a separate component of equity in a statement of financial position now be reported in a financial statement and displayed as prominently as other financial statements. Items that are required by accounting standards to be reported as direct adjustments to paid-in capital, retained earnings or other nonincome equity accounts are not to be included as components of comprehensive income.
|Exhibit 1: Items Included in Other Comprehensive Income|
|Here is a
listing of accounting standards that-prior to Statement no.
130-required certain items to bypass a statement of income and
to be reported in a balance within a separate component of
equity in a statement of financial position. |
THE VIEW FROM FASB 130
As defined in Statement no. 130, comprehensive income is the same as that in Concepts Statement no. 6 except Statement no. 130 divides it into net income and other comprehensive income, where net income is calculated the same as in the past and other comprehensive income includes (1) foreign currency items, (2) unrealized holding gains and losses on marketable securities defined as available-for-sale in Statement no. 115 and (3) additional minimum pension liability adjustments under Statement no. 87. In the past, companies did not include these other comprehensive income items in the income statement. Instead, the items were taken directly to a separate component of equity. Statement no. 130 does not affect the measurement of the three items included in other comprehensive income; it affects only where the information is presented.
Statement no. 130 does not address the recognition or measurement of comprehensive income; future pronouncements will address these issues. Rather, the FASB took several initial steps toward implementing a framework that establishes the first elements of comprehensive income, leaving further refinements for later.
Every business that provides a full set of financial statements reporting financial position, results of operations and cash flows must follow Statement no. 130. However, it does not apply to a company that has no items of other comprehensive income, nor does it apply to not-for-profit organizations. Statement no. 130 is effective for fiscal years beginning after December 15, 1997. Since total comprehensive income must be reported on interim financial statements, calendar-year corporations had to start reporting comprehensive income in the first-quarter statements of 1998. Statement no. 130 does not require companies to disclose comprehensive income in a specific place in the interim financial statements, nor does it require that they report the separate components of other comprehensive income.
WHAT TO INCLUDE AND WHERE
Items included in net income are displayed in various classifications, including income from continuing operations, discontinued operations, extraordinary items and cumulative effects of changes in accounting principle. Statement no. 130 does not alter those classifications or other requirements for reporting results from operations.
Since net income is a component of comprehensive income, items included in both must be adjusted to avoid double counting. For example, companies would have to adjust gains on investment securities classified as available-for-sale that were realized and included in net income for the period that also were included in other comprehensive income as unrealized holding gains in earlier periods or the present period. Statement no. 130 refers to these as reclassification adjustments.
Consider, for example, ABC Co. In the year it adopted Statement no. 130, it had activities relating to marketable securities defined as available-for-sale under Statement no. 115. Information on the company's portfolio—stock A in particular—is summarized in exhibit 2, below. At January 1, 199X, the company's portfolio consisted of 100 shares of stock A, which had a cost and market price of $10 per share and a portfolio of other stocks with a market price of $15,000. At March 31, 199X, the market price of stock A was $1,080 and that of the other stocks was $15,500. The market price for all the stock was $16,580-$580 more than the cost. ABC recognized an unrealized gain of $580 as other comprehensive income in its first-quarter financial statements. In the second and third quarters, it recognized and reported an additional $1,020 and $500, respectively, in other comprehensive income.
For the first three quarters, the total unrealized gain on stock A was $400; this amount was reflected in other comprehensive income. The company sold stock A on October 1, 199X, for $1,400, resulting in a realized gain that ABC included in its net income computation. If the company makes no adjustment to comprehensive income, the $400 gain is double counted. In exhibit 3, page 49, however, ABC includes in its statement of income and comprehensive income the $400 gain in income from operations of $25,000. In other comprehensive income, a ($400) reclassification adjustment—or ($300) aftertax—is included for ABC's sale of stock A.
A company must determine reclassification adjustments for each classification of other comprehensive income, except for minimum pension liability adjustments. The adjustment for foreign currency translation is to be limited to translation gains and losses realized on the sale or substantially complete liquidation of an investment in a foreign entity. A company may display reclassification adjustments on the face of the financial statement or in the notes to the financial statements.
DISPLAYING COMPREHENSIVE INCOME
Statement no. 130 provides three different approaches to displaying comprehensive income. Exhibits 3 and 4, pages 49 and 50, illustrate the one-statement and two-statement approaches, respectively, to reporting comprehensive income. Exhibit 5, page 52, illustrates how a company can display comprehensive income in the statement of changes in equity.
|Exhibit 2: ABC Co.—Available-for-Sale Securities|
In exhibit 3, net income is in the middle of the statement. This burying of net income with comprehensive income as the bottom line may not appeal to investors and accountants who are used to seeing net income as the bottom line. Components of other comprehensive income are shown before reclassification adjustments, and therefore no note disclosure is required for the reclassification adjustments of the available-for-sale securities that have unrealized gains of $400 before tax. Since the other comprehensive income is shown after tax, the notes to the financial statements must show the beforetax amounts, the tax expense/benefit and the aftertax amounts of each component of other comprehensive income.
Exhibit 4 illustrates the two-statement approach. The income statement is typical of one calculated in the past. The statement of comprehensive income begins with net income from the income statement, and other comprehensive income is added to calculate comprehensive income. Because other comprehensive income is presented after tax, a note is needed for the income before tax, the tax expense/benefit and the aftertax amounts of each component of other comprehensive income. This approach leaves the income statement unchanged from past income statements and adds an additional statement of comprehensive income. An alternative would be for a company to present the data before tax, subtract the total tax and in the notes disclose the amount of tax applicable to each component of other comprehensive income.
|Exhibit 3: One-Statement Approach to Reporting Comprehensive Income|
Note: This statement has been formatted in accordance with format A, one-statement approach, on page 42 of Statement no. 130.
Exhibit 5 uses a statement of changes in equity approach, where net income, other comprehensive income and comprehensive income are displayed. This method involves the fewest changes from current reporting. The FASB discourages companies from using this method because it tends to hide comprehensive income in the middle of the statement.
An entity should transfer the total of other comprehensive income for a period to a component of equity that is displayed separately from retained earnings and additional paid-in capital in a statement of financial position at the end of an accounting period. That component of equity should have a descriptive title such as "accumulated other comprehensive income." A company's disclosure on the face of the statement, in the statement of changes in equity or in notes to the financial statement of accumulated balances of each component of accumulated other comprehensive income should correspond to the classifications used in other financial statements for components of comprehensive income.
Companies must display net income, comprehensive income and other comprehensive income in one of the three recommended formats. The first decision a company should make is the format it will use in reporting comprehensive income. The second decision is whether to show the components of other comprehensive income net of reclassification adjustments. If it shows the components in this way, then the notes must display the unadjusted information.
|Exhibit 4: Two-Statement Approach to Reporting Comprehensive Income|
Note: This statement has been formatted in accordance with format B, two-statement approach, on page 43 of Statement no. 130.
Another decision companies face is whether to show the components of other comprehensive income on a beforetax or aftertax basis. If the components are shown before tax, then the company must display the aftertax amount applicable to each component of other comprehensive income in the notes to the financial statements. If the components of other comprehensive income are shown after tax, as they are in exhibits 3 and 4, the company must display the beforetax amount and the tax implications relative to each component in the notes to the financial statements. Finally, the company has options in how to display the individual components of accumulated other comprehensive income—either in the financial statements or in the notes to the financial statements.
To make these decisions, a company should immediately develop the data from prior periods so it can simulate past results under today's rules. A company should prepare post-forma financial statements for prior years to see how the company's statements would have looked had Statement no. 130 been in effect during that time. Although publicly reporting companies tend to try to "manage" their net income, it is much more difficult to manage comprehensive income than it is to manage net income. Companies should analyze the post-forma statements to gain insights about how future statements will appear to investors.
|Exhibit 5: Statement of Changes in Equity Approach to Reporting Comprehensive Income|
NOTE: This statement has been formatted in accordance with format C, statement of changes in equity approach (alternative 1), on page 44 of Statement no. 130.
Finally, a company should also keep in mind that, in the future, standard setters may include additional items in comprehensive income. Potential candidates for inclusion are additional accounting for pensions and gains and losses on transactions in derivative instruments. With an eye to the future, companies should begin to position themselves for the eventual inclusion of these components.
THE FIRST STEP
Companies should view Statement no. 130 as the FASB's first step on a considerable journey. Having established with this statement the framework for reporting comprehensive income, the FASB will go on over the next several years to refine accounting standards to add more elements to this framework, rendering comprehensive income more and more inclusive. If the objectives of reporting comprehensive income are met, financial statement readers should gain additional insights into a company's activities, which should enable them to better anticipate its future cash flows.