Accounting professionals have engaged in an ongoing debate concerning which transactions should be included as components of periodic income. For instance, some argue that certain changes in shareholders' equity besides those attributable to traditional net income should be included in the determination of income. In what might be viewed as a compromise, the FASB decided to maintain the traditional view of net income, but to require companies also to report an expanded version of income called comprehensive income traditional net income plus other nonowner changes in equity. to include four types of gains and losses that traditionally hadn't been included in income statements. Let's consider what that means.
Other Comprehensive Income
The calculation of net income omits certain types of gains and losses that are included in comprehensive income. As one example, in Chapter 12 you will learn that certain investments are reported in the balance sheet at their fair values, but that the gains and losses resulting from adjusting those investments to fair value might not be included in net income. Instead, they are reported as a separate component of shareholders' equity, other comprehensive income (OCI) (loss) certain gains and losses that are excluded from the calculation of net income, but included in the calculation of comprehensive income..
Companies must report both net income and comprehensive income and reconcile the difference between the two.42 Be sure to remember that net income actually is a part of comprehensive income. The reconciliation simply extends net income to include other comprehensive income items, reported net of tax, as shown in Illustration 4-8.
Comprehensive income is the total change in equity for a reporting period other than from transactions with owners.
*Changes in the market value of securities available for sale (described in ).43
†Gains and losses due to revising assumptions or market returns differing from expectations and prior service cost from amending the plan (described in ).
‡When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text).
§Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders' equity. (This item is discussed elsewhere in your accounting curriculum.)
The actual terminology used by companies for the four other comprehensive income items varies considerably. For instance, deferred gains (losses) from derivatives are sometimes called derivative mark-to-market adjustments or changes in fair value of derivatives, and gains (losses) from foreign currency translation are often identified as foreign currency translation adjustments.
Comprehensive income includes net income as well as other gains and losses that change shareholders’ equity but are not included in traditional net income.
Flexibility in Reporting
The presentation shown in Illustration 4-8 can be (a) included as an extension to the income statement, (b) reported (exactly the same way) as a separate statement of comprehensive income, usually as part of a disclosure note, or (c) included in the statement of changes in shareholders' equity (Chapter 18). Each component of other comprehensive income can be displayed net of tax, as in Illustration 4-8, or alternatively, before tax with one amount shown for the aggregate income tax expense (or benefit).44 A recent survey of reporting practices of 500 large public companies indicates that, of those companies that had other comprehensive income items, 84% chose to include the presentation of comprehensive income in their statements of changes in shareholders' equity.45
Reporting comprehensive income can be accomplished with a separate statement or by including the information in either the income statement or the statement of changes in shareholders' equity.
Many companies, though, such as McAfee, Inc., and The Standard Register Company, choose to present comprehensive income as an extension to their income statements. The Dell Inc. statements of stockholders' equity in the company's annual report (in Appendix B at the back of the text) provides an example of a presentation of comprehensive income in that statement. Chapter 18 also illustrates the presentation of comprehensive income in the statement of changes in shareholders' equity. On the other hand, in its 2009 financial statements, Astro-Med Inc., a manufacturer of a broad range of specialty technology products, chose to use the separate statement approach, as shown in Graphic 4-11.
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Comprehensive Income Presented as a Separate Statement—Astro-Med Inc.
Real World Financials
INTERNATIONAL FINANCIAL REPORTING STANDARDS
Comprehensive Income. As part of a joint project with the FASB, the International Accounting Standards Board (IASB) in 2007 issued a new version of IAS No. 1 46 that revised the standard to bring international reporting of comprehensive income largely in line with U.S. standards. It provides the option of presenting revenue and expense items and components of OCI either in (a) a single statement of comprehensive income or (b) in a separate income statement followed by a statement of comprehensive income. U.S. GAAP also allows the reporting of other comprehensive income in the statement of shareholders' equity.
Illustration 4-8 lists four possible OCI items according to U.S. GAAP. There is an additional possible item, changes in revaluation surplus, under IFRS. In Chapter 10 you will learn that IAS No. 16 47 permits companies to value property, plant, and equipment at (1) cost less accumulated depreciation or (2) fair value (revaluation). IAS No. 38 48 provides a similar option for the valuation of intangible assets. U.S. GAAP prohibits revaluation.
International standards do not allow the reporting of other comprehensive income in the statement of shareholders’ equity.
If the revaluation option is chosen and fair value is higher than book value, the difference, changes in revaluation surplus, is reported as other comprehensive income and then accumulates in a revaluation surplus account in equity.
Accumulated Other Comprehensive Income
In addition to reporting OCI that occurs in the current reporting period, we must also report these amounts on a cumulative basis in the balance sheet. This is consistent with the way we report net income that occurs in the current reporting period in the income statement and also report accumulated net income (that hasn't been distributed as dividends) in the balance sheet as retained earnings. Similarly, we report OCI as it occurs in the current reporting period and also report accumulated other comprehensive income (AOCI) amount of other comprehensive income (nonowner changes in equity other than net income) accumulated over the current and prior periods. in the balance sheet. This is demonstrated in Graphic 4-11. for Astro-Med Inc.
The cumulative total of OCI (or comprehensive loss) is reported as accumulated other comprehensive
income (AOCI), an additional component of shareholders’ equity that is displayed separately.
Shareholders' Equity—Astro-Med Inc.
Real World Financials
Referring to the numbers reported in Graphic 4-11, we can reconcile the changes in both retained earnings and AOCI:
AOCI decreased by $648 thousand, from $649 thousand to $1 thousand.
To further understand the relationship between net income and other comprehensive income, consider another example. Suppose Philips Corporation began 2011 with retained earnings of $600 million and accumulated other comprehensive income of $34 million. Let's also assume that net income for 2011, before considering the gain discussed below, is $100 million, of which $40 million was distributed to shareholders as dividends. Now assume that Philips purchased shares of IBM stock for $90 million during the year and sold them at year-end for $100 million. In that case, Philips would include the realized gain of $10 million in determining net income, If the income tax rate is 40%, net income includes a $6 million net-of-tax gain from the sale. This means that shareholders' equity, specifically retained earnings, also will include the $6 million.
On the other hand, what if the shares are not sold before the end of the fiscal year but the year-end fair value is $100 million and Philips accounts for the shares as securities available-for-sale? In that case, the unrealized gain of $10 million is not included in net income. Instead, $6 million net-of-tax gain is considered a component of other comprehensive income (loss) for 2011 and results in an increase in accumulated other comprehensive income (loss), rather than retained earnings, in the 2011 balance sheet. The total of retained earnings and accumulated other comprehensive income is $700 million either way, as demonstrated below.
If the shares are not sold, the unrealized gain is part of other comprehensive income.
Net income and comprehensive income are identical for an enterprise that has no other comprehensive income items. Components of other comprehensive income are described in subsequent chapters.
INCOME STATEMENT PRESENTATION
The Barrington Construction Company builds office buildings. It also owns and operates a chain of motels throughout the Northwest. On September 30, 2011, the company decided to sell the entire motel business for $40 million. The sale was completed on December 15, 2011. Income statement information for 2011 is provided below for the two components of the company.
*For the motel component, the entire Other income (loss) amount represents the loss on sale of assets of the component for $40 million when their book value was $70 million.
†A 40% tax rate applies to all items of income or loss.
In addition to the revenues and expenses of the construction and motel components, Barrington experienced a before-tax loss of $20 million to its construction business from damage to buildings and equipment caused by volcanic activity at Mount St. Helens. The event was considered unusual and infrequent.
Prepare a 2011 income statement for the Barrington Construction Company including EPS disclosures. There were 100 million shares of common stock outstanding throughout 2011. The company had no potential common shares outstanding.
Now that we have discussed the presentation and content of the income statement, we turn our attention to the statement of cash flows.
42 FASB ASC 220–10–45: Comprehensive Income–Overall–Other Presentation Matters (previously “Reporting Comprehensive Income,” Statement of Financial Accounting Standards No. 130 (Norwalk, Conn.: FASB, 1997)).
43 An unrealized loss also might occur from recording an impairment of a held-to-maturity (HTM) investment. As described in Chapter 12, if the fair value of an HTM investment falls below its amortized cost, and that decline if viewed as other than temporary, the current period credit loss is included in net income, but any amount that exceeds the current period credit loss is recorded as a loss in Other Comprehensive Income.
44 GAAP does not require the reporting of comprehensive earnings per share.
45Accounting Trends and Techniques—2009 (New York: AICPA, 2009), p. 447.
46 “Financial Statement Presentation,” International Accounting Standard No. 1 (IASCF), as amended effective January 1, 2009.
47 “Property, Plant and Equipment,” International Accounting Standard No. 16 (IASCF), as amended effective January 1, 2009.
48 “Intangible Assets,” International Accounting Standard No. 38 (IASCF), as amended effective January 1, 2009.