Journal of Accountancy, May 1998 v185 n5 p45(7)
How companies report income. Randall W. Luecke; David T.
Meeting.
Abstract: Income accounting Statement number 130 issued by the FASB represents
further movement toward all-inclusive or comprehensive income reporting
where
extraordinary gains and losses are included in the accounting. Items of
income are
reported in the accounting period in which they are recognized. Reference
to detailed
explanations and examples may be useful.
Full Text: COPYRIGHT 1998 American Institute of Certified Public Accountants
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 is sued 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
1. Financial position at the end of the period.
2. Earnings (net income).
3. Comprehensive income (total nonowner changes in equity).
4. Cash flows during the period.
5 . 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.
Statement no. 130 does not address the recognition or measurement of comprehensive
income. These will be addressed in future pronouncements.
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 i statement of financial position.
Item
Foreign currency translation adjustments.
Gains and losses on foreign currency transactions that are designated as,
and are
effective as, economic hedges of a net investment in a foreign entity,
commencing as of
the designation date.
Gains and losses on intercompany foreign currency transactions that are
of a long-term
investment nature when entities to the transactions are consolidated, combined
or
accounted for by the equity method in the reporting enterprise's financial
statements.
A change in the market value of a futures contract that qualifies as a
hedge of an asset
reported at fair value under Statement no. 115.
A net loss recognized pursuant to Statement no. 87 as an additional pension
liability not
yet recognized as net periodic pension cost.
Unrealized holding gains and losses on available-for-sale securities.
Unrealized holding gains and losses that result from a debt security being
transferred into
the available-for-sale category from the held-to-maturity category.
Subsequent decreases or increases in the fair value of available-for-sale
securities
previously written down as impaired.
Citation
Statement no. 52, paragraph 13.
Statement no. 52, paragraph 20(a).
Statement no. 52, paragraph 20(b),
Statement no. 80, paragraph 5.
Statement no. 87, paragraph 37.
Statement no. 115, paragraph 13
Statement no. 115, paragraph 15(c).
Statement no. 115, paragraph 16.
... 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. t30 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.
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.
Exhibit 2: A 2: ABC Securities
Available-for-Sale Portfolio
1/1/9X 3/31/9X
Stock A 100 @ $10
$1,000 $1,080
Other portfolio stocks
$15,000 $15,500
Total portfolio
$16,000 $16,580
Gain per quarter (included
in comprehensive income):
Stock A
$80
Other stocks
500
Total unrealized gain
$586
Cumulative unrealized gain
$580
Reclassification to realized
gain (included in net income)
Net unrealized gains for the year,
after reclassification adjustments,
before tax
Sale of Stock A Sale price @ 10/1/9X
$1,400
Cost/basis
1,000
Realized gain
400
Tax @ 25%
100
Aftertax gain
$ 300
6/30/9X 9/30/9X
Stock A 100 @ $10
$1,300 $1,400
Other portfolio stocks
$16,300 $16,700
Total portfolio
$17,600 $18,100
Gain per quarter (included
in comprehensive income):
Stock A
$ 220 $100
Other stocks
800 400
Total unrealized gain
$1,020 $500
Cumulative unrealized gain
$1,600 $2,100
Reclassification to realized
gain (included in net income)
Net unrealized gains for the year,
after reclassification adjustments,
before tax
Sale of Stock A Sale price @ 10/1/9X
Cost/basis
Realized gain
Tax @ 25%
Aftertax gain
12/31/9X
Stock A 100 @ $10
Other portfolio stocks
$17,400
Total portfolio
$17,400
Gain per quarter (included
in comprehensive income):
Stock A
Other stocks
$700
Total unrealized gain
$700
Cumulative unrealized gain
$2,800
Reclassification to realized
gain (included in net income)
$(400)
Net unrealized gains for the year,
after reclassification adjustments,
before tax
$2,400
Sale of Stock A Sale price @ 10/1/9X
Cost/basis
Realized gain
Tax @ 25%
Aftertax gain
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 ABCs 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 3: One-Statement Approach to Reporting
Comprehensive Income
ABC Co.
Statement of Income and Comprehensive Income
Year Ended December 31, 199X
Revenues
$28,000
Expenses
(5,000)
Other gains and losses
1,600
Gain on sale of securities
400
Income from operations before tax
25,000
Income tax expense
(6,250)
Income before extraordinary item
and cumulative effect of
accounting change
18,750
Extraordinary item, net of tax
(5,600)
Income before cumulative effect
of accounting change
13,150
Cumulative effect of accounting
change, net of tax
(500)
Net income
12,650
Other comprehensive income,
net of tax:
Foreign currency translation adjustments
2,400
Unrealized gains on securities:
Unrealized holding gains arising
during period
$2,100
Less: Reclassification adjustment
for gains included in net income
(300) 1,800
Minimum pension liability adjustment
(600)
Other comprehensive income
3,600
Comprehensive income
$16,250
ABC Co.
Notes to the Financial Statements
Year Ended December 31, 199X
Note X
During the year, the ABC Co. adopted FASB Statement no. 130, Reporting
Comprehensive Income. Statement no. 130 requires the reporting of comprehensive
income in addition to net income from operations. Comprehensive income
is a more
inclusive financial reporting methodology that includes disclosure of certain
financial
information that historically has not been recognized in the calculation
of net income.
During the year, ABC Co. engaged in numerous transactions involving foreign
currency,
resulting in unrealized gains of $3,200 before tax. In addition, the company
at yearend
held securities classified as available-for-sale, which have unrealized
gains of $2,400
before tax. Finally, in compliance with Statement no. 130, the company
as part of
comprehensive income recognizes a beforetax increase in minimum pension
liability of
$800. The beforetax and aftertax amount for each of these categories, as
well as the tax
(expense)/benefit of each, is summarized below.
Tax
Before (Expense)/ After
Tax Benefit
Tax
Foreign currency translation $3,200
$(800) $2,400
Unrealized holding gains
2,800 (700)
2,100
Reclassification adjustment for
gains included in net income
(400) 100
(300)
Minimum pension liability
(800) 200
(600)
$4,800 ($1,200) $3,600
Note: This statement has been formatted in accordance with format A, one-statement
approach, on page 42 of Statement no. 130.
Exhibit 4: Two-Statement Approach to Reporting
Comprehensive Income
ABC Co.
Statement of Income
Year Ended December 31, 199X
Revenues
$28,000
Expenses
(5,000)
Other gains and losses
1,600
Gain on sale of securities
400
Income from operations before tax
25,000
Income tax expense
(6,250)
Income before extraordinary item
and cumulative effect of accounting
change
18,750
Extraordinary item, net of tax
(5,600)
Income before cumulative effect of
accounting change
13,150
Cumulative effect of accounting
change, net of tax
(500)
Net income
$12,650
ABC Co.
Statement of Comprehensive Income
Year Ended December 31, 199X
Net income $12,650
Other comprehensive income,
net of tax:
Foreign currency translation
adjustments
2,400
Unrealized gains on securities:
Unrealized holding gains arising
during period
$2,100
Less: reclassification
adjustment for gains
included in net income
(300) 1,800
Minimum pension liability adjustment
(600)
Other comprehensive income
3,600
Comprehensive income
$16,250
ABC Co.
Notes to the Financial Statements
Year Ended December 31, 199X
Note X
During the year, the ABC Go. adopted FASB Statement no. 130, Reporting
Comprehensive Income. Statement no. 130 requires the reporting of comprehensive
income in addition to net income from operations. Comprehensive income
is a more
inclusive financial reporting methodology that includes disclosure of certain
financial
information that historically has not been recognized in the calculation
of net income.
During the year, ABC Co. engaged in numerous transactions involving foreign
currency,
resulting in unrealized gains of $3,200 before tax. In addition, the company
at yearend
held securities classified as available-for-sale, which have unrealized
gains of $2,400
before tax Finally, in compliance with Statement no. 130, the company as
part of
comprehensive income recognizes a beforetax increase in minimum pension
liability of
$800. The beforetax and aftertax amount for each of these categories, as
well as the tax
(expense)/benefit of each, is summarized below.
Tax
Before (Expenses)/ After
Tax Benefit
Tax
Foreign currency translation $3,200
$(800) $2,400
Unrealized holding gains
2,800 (700)
2,100
Reclassification adjustment
for gains included in net
income
(400) 100
(300)
Minimum pension liability
(800) 200
(600)
$4,800 ($1,200)
$3,600
Note: This statement has been formatted in accordance with format B, two-statement
approach, on page 43 of Statement no. 130.
Exhibit 5: Statement of Changes in Equity Approach to Reporting Comprehensive
Income
ABC Co.
Statement of Changes in Equity
Year Ended December 31, 199X
Comprehensive Retained
Total Income
Earnings
Beginning balance $107,700
$17,700
Comprehensive income
Net income
12,650 $12,650
$12,650
Other comprehensive
income, net of tax
Unrealized gains on
securities, net of
reclassification
adjustment (see
disclosure)
1,800 1,800
Foreign currency
translation
adjustments
2,400 2,400
Minimum pension
liability
adjustment
(600) (600)
Other comprehensive
income
3,600
Comprehensive income
16,250
Common stock issued 30,000
Dividends declared on
common stock
(2,000)
(2,000)
Ending balance
151,950
128,350
Disclosure of
reclassification
amount:
Unrealized holding
gains arising
during period
$2,100
Less: reclassification
adjustment for gains
included in net
income
(300)
Net unrealized gains
on securities
$1,800
Accumulated
Other
Comprehensive Common Paid-in
Income Stock
Capital
Beginning balance
$30,000 $60,000
Comprehensive income
Net income
Other comprehensive
income, net of tax
Unrealized gains on
securities, net of
reclassification
adjustment (see
disclosure)
Foreign currency
translation
adjustments
Minimum pension
liability
adjustment
Other comprehensive
income
3,600
Comprehensive income
Common stock issued
10,000 20,000
Dividends declared on
common stock
Ending balance
$3,600 140,000
$80,000
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.
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 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.
IMPLEMENTATION GUIDELINES
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.
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.
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.
RELATED ARTICLE: EXECUTIVE SUMMARY
* WITH ITS ISSUANCE OF STATEMENT NO. 130, Reporting Comprehensive
Income, the FASB is moving closer to the all-inclusive method of income
determination.
The statement is effective for fiscal years beginning after December 15,
1997.
* AN ENTERPRISE REPORTS comprehensive income-nonowner changes in
equity--to reflect all of the changes in its equity resulting from recognized
transactions
and other economic events in a period. Statement no. 130 requires companies
to report
in a financial statement for the period in which they are recognized all
items meeting the
definition of components of comprehensive income.
* STATEMENT NO.
130 DIVIDES
comprehensive income
into net income and other
comprehensive income,
which includes foreign
currency items, unrealized
holding gains and losses
on marketable securities
defined as
available-for-sale and
additional minimum pension liability adjustments. The statement does not
address the
recognition or measurement of comprehensive income but, rather, establishes
a
framework that can be refined later.
* COMPANIES HAVE THREE WAYS TO display comprehensive income, including
the one- and two-statement approaches and displaying it in the statement
of changes in
equity. The FASB discourages use of the third method because it hides comprehensive
income in the middle of the financial statement.
* AS THEY UNDERTAKE IMPLEMENTATION of Statement no. 130, companies
must decide what format they will use in reporting comprehensive income.
They also
must decide whether to show components of comprehensive income net of
reclassification adjustments and whether to show the components on a before-
or
aftertax basis.
RANDALL W. LUECKE, CPA, CMA is vice-president-administration and treasurer
of International Approval Services, Cleveland. IAS is a division of the
Canadian
Standards Association. DAVID T. MEETING, CPA, DBA, is associate professor
of
accounting at Cleveland State University.
Article A20641589