Executive Summary
SFAS 130 requires an entity to report comprehensive income and the components of other comprehensive income in a full set of financial statements. The objective of this standard is to report all items that meet the definition of comprehensive income, specifically in a financial statement in the period of recognition of those items of comprehensive income. The purpose of this essay is to summarize the major issues taken up by SFAS 130 with regard to comprehensive income and also to emphasize the effects of different methods of calculations of comprehensive income suggested by SFAS 130.
Comprehensive Income
“Comprehensive Income is defined as the change in equity of a business during a period from transactions of non- owners. Shareholders are the owners of the corporation or entity. Therefore, the transactions between entity and shareholders are not part of components of comprehensive income.”(Whittington and Delaney, page 164). Simply, comprehensive income is the net change in owner’ equity, excluding the effects of investments by owners and distributions to owners. As a result, comprehensive income includes all the components that make up net income. In addition, several items that are reported as adjustments directly to stockholders’ equity and that are not included in the computation of net income are included in comprehensive income.
Paragraph 15 of SFAS 130 has divided the comprehensive income into two parts, namely net income and other comprehensive income. The entities that do not have other comprehensive income need not report comprehensive income.
Other Comprehensive income
Adjustments that are directly made to shareholders’ equity make up a component of comprehensive income referred to as other comprehensive income. Paragraph 17 of SFAS 130 describes the classification of other comprehensive income. The paragraph states that “items included in other comprehensive income shall be classified based on their nature. For example, under existing accounting standards, other comprehensive income shall be classified separately into foreign currency items, gains or losses associated with pensions or post-retirement benefits, prior service costs or credits associated with a pension or other post-retirement benefits, transition assets or obligations associated with pensions or other post-retirement benefits, and unrealized gains and losses on certain investments in debt and equity securities. Additional classification or additional items within current classifications may result from future accounting standards.”(SFAS 130, paragraph 17).
Accordingly, based on the above information from paragraph 17 of SFAS 130, few examples of other comprehensive income currently consist of adjustment related to:
- Unrealized gains or losses due to changes in values of marketable securities classified as available for sale.
- Unrealized gains and losses due to changes in values of certain derivatives that are effective as hedges.
- Translation adjustments due to changes in foreign exchange rate affecting a foreign subsidiary.
- Amounts in excess of unrecognized prior service cost reported when accruing an additional liability based on the excess of the accumulated benefits obligation over plan assets.
Comprehensive Income Disclosures
It is pertinent to note that SFAS does not require any particular format to report comprehensive income, though it has suggested few alternative formats. The basic requirement of SFAS is to show net income as a component of comprehensive income. It has further stated that comprehensive income should be displayed with the same prominence as the financial statements.
SFAS 130 has not brought any change to the reporting requirements of net income. It has made regulations for disclosing other comprehensive income alongside net income. Though SFAS 130 requires that comprehensive income and its components should be displayed prominently in a financial statement, it has not specified a format for such disclosure. It has only stated that net income should be part of displayed comprehensive income. However, the standard has suggested three alternative formats that can be followed to disclose comprehensive income.
As per SFAS 130, “an enterprise may choose one of the following formats for reporting comprehensive income:
- Display OCI below net income on the income statement.
- Present a separate statement of comprehensive income.
- Report Comprehensive income in the statement of changes in stockholders’ equity.” (Sak Bhamornsiri and Casper Wiggins, 2001).
Accordingly, the companies are required to decide first about the form of the financial statement where comprehensive income will be displayed. The second issue is concerning the reclassification of OCI components at reporting those components. Reclassification is also important as the company has to provide comparative information of the prior year.
SFAS 130 also requires that all items of other comprehensive income other than minimum pension liability adjustments should be reported either at a gross amount. Alternatively, the net amount can also be reported with the gross amount stated in the notes to the accounts. The purpose is that reclassification adjustment must be apparently displayed while reporting the components of comprehensive income, including the adjustments of other comprehensive income.
Another feature of SFAS 130 is that items of comprehensive should either be reported as net of taxes. The alternative to this is to disclose the tax effects on the statement of comprehensive income itself or in the notes to the accounts. SFAS does not treat reporting Earning per share (EPS) as part of the statement of comprehensive income.
Selection of financial statement and reporting comprehensive income in Balance Sheet
The most important issue that arises from the regulations provided in SFAS 130 for a company is the selection of financial statements wherein comprehensive income components should be reported as the regulations have provided three alternatives, as stated in the previous section of this write-up. The companies have options of selections from one-income statement, two-income statement, and the statement of changes in equity.
If the selection is made of a one-income statement, it will better be called the statement of income and comprehensive income. Under this, income is calculated in a regular fashion in one section of the statement, and the other section incorporates the components of comprehensive income. After calculating the net income in the first section, it will be carried down to the next section containing comprehensive income.
As the name suggests, the ‘two-income statement’ statement comprises two separate statements. The first statement, called ‘Income Statement,’ will include net income calculations as prescribed in the GAAP. The second statement will be called the ‘Statement of Comprehensive Income.’ This second statement will start from the net income calculated in the first statement and then include all components of other comprehensive income. As is clear, components of other comprehensive income contain those items that cannot be included in the income statement.
The third alternative is to use the ‘statement of changes in equity.’ Again the section of comprehensive income in the ‘statement of changes in equity’ will begin with net income and then be followed by components of other comprehensive income.
The pertinent point is which alternative is being followed by most of the companies out of the three alternatives stated above. A number of surveys have been conducted with this regard to find out the trend amongst the companies in the selection of an alternative out of the three available as per SFAS 130. In this regard, Philips, Jeffery J (2004) is of the opinion and has stated that “Using the third format for reporting comprehensive income would enable those companies to obscure any undesirable impact of negative OCI (other comprehensive income) component on the annual financial statements by hiding it in the statement of changes in 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 the comprehensive income 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 format for the NYSE companies in the sample.” That clearly means the third format of reporting comprehensive in the statement of changes in stockholders’ equity is gaining popularity since the introduction of SFAS 130 in 1997.
After recording components of comprehensive income in one of three alternatives, as discussed above, the matter of balance sheet presentation of comprehensive income gains importance as per regulations provided in SFAS 130, “The accumulated balance of other comprehensive income items is to be reported in the equity section of the balance sheet in a category separate from contributed capital and retained earnings. Within this separate category, the accumulated balance of each individual item may be reported or, alternately, a total of all items may be reported. If only a total is presented, individual balances must be reported either in the statement of changes in equity or in the notes to financial statements.”(Strickland & Carter, 1997).
There is an important terminology that SFAS 130 has prescribed and desired to be used while displaying comprehensive income in the balance sheet. “SFAS 130 uses the term ‘accumulated other comprehensive income‘ to refer to the aggregate amount of a company’s other comprehensive income components and requires that amount be reported in the equity section of the balance sheet separately from retained earnings, paid-in capital, and other non-income equity accounts. SFAS 130 also requires the individual components comprising accumulated other comprehensive income (for example, gains and losses on available-for-sale securities and foreign currency translation adjustments) to be disclosed either on the face of the balance sheet, in the statement of changes in equity, or in a note to the financial statements.”(Gary J Bruchle and Cheri L Reither, 1997).
In a nutshell, SFAS 130 requires “that firms with items of other comprehensive income reports:
- The closing balance of each such item. Their total is reported as a separate component of equity called accumulated other comprehensive income.
- The change (either pretax or post-tax) in each item; the change can be reported as either gross (showing both addition and subtractions) or net.
- Reclassification adjustment to avoid double counting. For example, realized investment gains that include unrealized gains from prior years would be double-counted unless those realized gains are deducted from other comprehensive in the year of realization.
- Total comprehensive income in condensed financial statements provided for interim periods.
Alternative displays are permitted. For example, firms can provide a separate statement of comprehensive income or can combine that statement with the income statement. Some data can be reported either on statement face or in footnotes.” (A.C.Sondhi & Associates, 1997).
Interim Period Reporting
It is required under SFAS 130 that comprehensive income should also be reported in condensed financial statements for interim periods. But the application has been relaxed a little bit. It is not compulsorily required to provide information about individual components of comprehensive income in the interim reporting of comprehensive income. But there may be circumstances where the company may find significant differences between net income and comprehensive. Under such a situation, the company may report components of comprehensive income voluntarily in the interim reporting to shareholders.
Impact of comprehensive reporting on large companies
Reporting of comprehensive income as per SFAS 130 has impacted larger companies in more than one way.
“First, if the firm’s functional currency is a foreign currency and the firm uses the current rate method, then the translation adjustments will be reported in other comprehensive income. This will not affect firms that use the temporal method since the adjustment is incorporated in the income statement.
Second, if the firm has unrealized gains or losses on investments in debt or equity, classified as ‘available-for-sale’ under SFAS no. 115, these unrealized gains or losses will be reported as other comprehensive income.
Third, if the firm has additional minimum pension liabilities under SFAS no. 87 that were formerly recognized in the shareholders’ equity section of the balance sheet, those increases (decreases) in the minimum pension liabilities will now be reported in the other comprehensive income.” (Arundhati & Robert J.,page 2).
Application of SFAS no.130 by Wal- Mart Stores Inc.
Wal-Mart Stores Inc. is following the third option of reporting comprehensive income available under SFAS no. 130. That is to say Wal- Mart is reporting comprehensive income in the ‘statement of shareholders’ equity,’ which is a trend as we have seen in this write-up earlier.
As per statements provided in its annual report 2008′ the statement starts with the beginning balance of comprehensive income as of January 31, 2007. To this is added net income for 2008. Thereafter, the components of ‘other comprehensive income’ are added. The other comprehensive income components include two adjustments, namely, the foreign currency translation adjustments and the adjustments relating to minimum pension liability. The total of these items results in total comprehensive income. The ending balance of total comprehensive income has been reported in the equity section of the balance sheet as ‘accumulated other comprehensive income.’
The important feature of Wal- Mart reporting of comprehensive income is that details of other comprehensive income constitute a part of the statement of shareholders equity, and this statement has been classified in such a fashion that the ending balance of accumulated other comprehensive is distinctively shown in the closing totals in order to avoid confusion of any sort. Also, the effects of components of other comprehensive income adjustments have been taken net of taxes, and this has been aptly declared in the notes to the accounts.
In notes to consolidated financial statements in Wal- Mart’s annual report 2008, it is stated at note no 4 that “Comprehensive income is net income plus certain other items that are recorded directly to shareholders’ equity. Amounts included in the accumulated other comprehensive income for the company’s derivative instruments and minimum pension liabilities are recorded net of the related tax effects.” (Annual Report 2008, Notes 4).
Notes to the accounts also contain reclassification of components for other comprehensive income for the earlier year before arriving at the beginning balance. However, there are no reclassifications pertaining to components of this year’s other comprehensive income.
Conclusion
SFAS 130 is a progressive inclusion to US GAAP that has provided a disciplined disclosure to issues that are concerned with different types of users of financial statements. The most important among them are shareholders who have the right to know how exactly the shareholders’ equity is being constituted. The presentation of comprehensive income also becomes important when components of other comprehensive income are influential enough to overshadow net income, and under those circumstances, investors need a careful review of investments. Another important feature of this study is that most companies are following the third alternative of presentation, which is progressive as the only third alternative is modern in the approach of presentation of financial statements.
Reference
Whittington and Delaney, Wiley CPA Exam Review 2008, John Wiley & Sons, 2007, page 164.
SFAS 130, Reporting Comprehensive Income, paragraph 17, Web.
Sak Bhamornsiri and Casper Wiggins, Comprehensive Income Disclosures, The CPA Journal, 2001, Web.
Philips, Jeffery J, Comprehensive Income: Reporting Preferences of Public Companies, The CPA Journal, 2004. Web.
Strickland & Carter, Reporting Comprehensive Income: SAS no. 130, National Public Accountant, 1997. Web.
Gary J Bruchle and Cheri L Reither, Reporting Comprehensive Income, The CPA Journal, 1997. Web.
A C Sondhi & Associates, SFAS 130 Reporting of Comprehensive Income, 1997, Web.
Arundhati & Robert J., Impact of “reporting comprehensive income” on large multinational firms, 1999, page 2, Web.
Annual Report 2008, Wal- Mart Stores Inc., page 30, Web.