| Comprehensive
Income: Reporting Preferences of Public Companies
By
Ganesh M. Pandit and Jeffrey J. Phillips
In June
1997, FASB released SFAS 130, Reporting of Comprehensive
Income, effective for fiscal years beginning after December
15, 1997. This statement established certain standards for
reporting and presenting comprehensive income in the general-purpose
financial statements. SFAS 130 was issued in response to users’
concerns that certain changes in assets and liabilities were
bypassing the income statement and appearing in the statement
of changes in stockholders’ equity. The purpose of SFAS
130 was to report all items that met the definition of “comprehensive
income” in a prominent financial statement for the same
period in which they were recognized. In accordance with the
definition provided by Statement of Financial Accounting Concepts
No. 6, comprehensive income was to include all changes in
owners’ equity that resulted from transactions of the
business entity with nonowners. According
to SFAS 130, “other comprehensive income” (OCI)
is part of total comprehensive income but generally excluded
from net income. Prior to SFAS 130, these three items—foreign
currency translation adjustments, minimum pension liability
adjustments, and unrealized gains or losses on available-for-sale
investments—were disclosed as separate components
of stockholders’ equity on the balance sheet. Under
SFAS 130, they are to be reported as OCI. Furthermore, they
must be reported separately, as FASB decided that information
about each component is more important than information
about the aggregate. Later,
net unrealized losses on SFAS 133 derivatives were also
included in the definition of OCI. The intent of SFAS 130
was that “if used with related disclosures and other
information in financial statements, the information provided
by reporting comprehensive income would assist investors,
creditors, and other financial statement users in assessing
an enterprise’s economic activities and its timing
and magnitude of future cash flows.”
While
FASB required that “an enterprise shall display total
comprehensive income and its components in a financial statement
that is displayed with the same prominence as other financial
statements that constitute a full set of financial statements”
(FASB 1997, para 22), it did not specify which format was
required, except that net income should be shown as a component
of comprehensive income in that financial statement. According
to SFAS 130, three alternative formats are allowed for presenting
OCI and total comprehensive income:
-
Below the line for net income in a traditional income
statement (as a combined statement of net income and comprehensive
income);
- In
a separate statement of comprehensive income that begins
with the amount of net income for the year; or
- In
a statement of changes in stockholders’ equity.
Under
SFAS 130, FASB encourages reporting entities to display
the components of OCI and total comprehensive income using
the first or second format above. Cumulative total OCI for
the period should be presented on the balance sheet as a
component of stockholders’ equity, separate from additional
paid-in capital and retained earnings.
Presentation
of Comprehensive Income
Since
the release of SFAS 130, several studies have examined the
presentation of comprehensive income. Campbell et al. (Ohio
CPA Journal, January–March 1999) studied a sample
of 73 early adopters of SFAS 130 and found that the majority
of companies chose to report comprehensive income in the
statement of stockholders’ equity. The same researchers
found that “the firms that chose the statement of
stockholders’ equity format had a materially negative
amount of OCI” (page 18). Bhamornsiri and Wiggins
(The CPA Journal, October 2001) found that a significant
number of firms in the S&P 100 reported comprehensive
income in the statement of changes in stockholders’
equity, regardless of whether the OCI was negative or positive.
They also found that foreign currency translation adjustments
represented the largest component of OCI.
The
purpose of the current study was to examine the presentation
of comprehensive income in the financial statements of a
sample of companies listed on the New York Stock Exchange
(NYSE) to determine which format predominates five years
after the release of SFAS 130. The significant decline in
stock prices during the years 2000–2002 might have
caused several companies to experience huge unrealized losses
on their investment portfolios, a potential component of
OCI if those investments were categorized as available-for-sale
securities. Using the third format for reporting comprehensive
income would enable those companies to obscure any undesirable
impact of a negative OCI component on the annual financial
statements by “hiding” it in the statement of
changes in stockholders’ equity. In order to confirm
this expectation, the authors also examined if the reporting
of OCI and total comprehensive income in one of the three
prescribed formats was highly correlated with a positive
or negative OCI. Finally, the study also found other items
pertaining to reporting comprehensive income in the financial
statements of the sample companies. Overall, five years
after SFAS 130 was adopted, reporting comprehensive income
in the statement of changes in stockholders’ equity
remained the most popular presentation format for the NYSE
companies in the sample.
Findings
The
data for this study were collected from a random sample
of 100 annual reports of NYSE-listed companies. Annual reports
for fiscal periods ending on or after December 31, 2002,
were examined for the presentation of OCI and total comprehensive
income.
The
study showed that 89 of the 100 companies used the third
format, which included OCI and total comprehensive income
in the statement of changes in stockholders’ equity.
Only nine of the sample companies chose the second format
and presented a separate statement of comprehensive income.
The remaining two companies chose the first format and presented
comprehensive income as a component of their income statements.
These finding were consistent with those of the two studies
mentioned earlier. Reporting comprehensive income in the
statement of changes in stockholders’ equity is still
the predominant presentation. This may be because this format
requires very little change from the former practice of
presenting the components of OCI under stockholders’
equity.
Of
the 89 companies that used the statement of changes in stockholders’
equity to report OCI, only 31 companies reported overall
positive OCI, while the remaining 58 companies reported
overall negative OCI. This finding is largely consistent
with that of Campbell et al. in that a significant percentage—65%—of
the companies in the current sample that chose the third
reporting format had negative OCI. Companies with negative
OCI were almost twice as likely to present it in the statement
of changes in stockholders’ equity, despite FASB’s
preference that these items be shown either in the income
statement or in a separate statement of comprehensive income.
Both companies that used the first format had negative OCI,
whereas, of the nine companies that used the second format,
six had negative OCI and three had positive OCI.
The
study also furnished other observations pertaining to the
presentation of OCI and total comprehensive income. For
example, a total of six companies did not provide details
of OCI in the body of their financial statements as presented
in the annual reports. Instead, these details were presented
in the notes to financial statements, despite the FASB’s
preference that components of OCI be presented prominently
in the financial statements. Furthermore, 14 companies included
the term “Comprehensive Income” in the title
of the financial statement where OCI and total comprehensive
income were presented, while the other 86 companies did
not. Also, there was not complete uniformity among the companies
in the sample as to the use of the term comprehensive income.
For example, while IBM referred to it as “Gains and
(losses) not affecting Retained Earnings,” GE called
it “Changes other than transactions with shareowners.”
Ruddick Corporation prepared a separate statement of comprehensive
income but called it “Statement of Non-owner Changes
in Equity.”
Among
the components of OCI, unrealized loss on available-for-sale
investments and minimum pension liability adjustment were
by far the more significant items for a large number of
companies that reported overall negative OCI. One reason
for this could be the recent decline in the stock market,
which probably caused the values of investments to weaken.
Furthermore, the decline in the fair values of pension fund
investments may have caused those pension plans to be underfunded
and required the companies to report increased adjustment
to their minimum pension liability.
Among
the companies that chose to report OCI in the statement
of changes in stockholders’ equity, the presentation
of total comprehensive income in the financial statements
was not uniform. While four companies presented total comprehensive
income in the notes to financial statements, as mentioned
earlier, approximately 40% of the companies presented total
comprehensive income in a separate column, while the remaining
companies reported total comprehensive income within the
total stockholders’ equity column in the statement
of changes in stockholders’ equity.
Transactions
with Nonowners
While
all NYSE companies in the sample were reporting the changes
in stockholders’ equity from transactions with nonowners
in accordance with SFAS 130, there was a very strong preference
among these companies for using the third presentation format,
which was to report it in the statement of changes in stockholders’
equity. This may be because it is closer to what the companies
were accustomed to using before the adoption of SFAS 130,
or it may be less prominent in this display, given the negative
character of the other comprehensive income. Moreover, there
was a lack of uniformity among these companies in adhering
to the language recommended by FASB. In general, some companies,
especially the larger ones in the sample, chose to follow
their own preferences when referring to comprehensive income
or presenting the details of the required information pertaining
to OCI.
Currently,
there is not sufficient evidence to indicate that comprehensive
income is a better predictor of future cash flows or has
an impact on stock prices. Less sophisticated investors,
however, are apparently more likely to use comprehensive
income information for corporate and management performance
assessment if it is included in a separate statement of
comprehensive income (Maines and McDaniel, 2000). Furthermore,
financial analysts are more likely to detect evidence of
earnings management on certain items only if presented in
a separate statement of comprehensive income (Hirst and
Hopkins, 1998).
If
investors place more emphasis on OCI and total comprehensive
income in the future, companies should be required to uniformly
present details of comprehensive income. If comprehensive
income becomes an important input for financial statement
users, more FASB guidance may be needed about the format
for its presentation.
Ganesh
M. Pandit, DBA, CPA, CMA, is an associate professor
of accounting, and Jeffrey J. Phillips, PhD, CPA,
is an associate professor and chairman of accounting, both
at the school of business administration, Clark Atlanta University,
Atlanta, Ga. |