A Statement Of Comprehensive Income Does Not Include

A statement of comprehensive income provides a broader view of a company's financial performance than a traditional income statement, but certain items are excluded to maintain clarity and focus on core operational results. Understanding what doesn't belong in this statement is just as important as knowing what does.

Comprehensive Income: A Quick Recap

Before delving into the exclusions, let's briefly define comprehensive income. It's the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

Essentially, it's net income plus other comprehensive income (OCI). OCI includes items that bypass the income statement because they haven't yet been realized. These are typically unrealized gains or losses.

What a Statement of Comprehensive Income Does Include

To understand the exclusions, it's helpful to first solidify what is included. The statement generally encompasses:

Net Income: This is the "bottom line" from the traditional income statement, representing revenue less expenses.
Other Comprehensive Income (OCI): This includes items like:
- Unrealized gains/losses on available-for-sale securities: Changes in the fair value of these investments that haven't been sold yet.
- Gains/losses from derivative instruments designated as cash flow hedges: Changes in the value of derivatives used to hedge future cash flows.
- Foreign currency translation adjustments: Gains or losses resulting from translating the financial statements of foreign subsidiaries into the reporting currency.
- Certain pension adjustments: Adjustments related to defined benefit pension plans.
- Revaluation surplus: Changes in the value of certain assets under IFRS accounting standards.

Items Excluded from the Statement of Comprehensive Income

Now, let's get to the heart of the matter: what doesn't belong in the statement of comprehensive income. These exclusions generally fall into the following categories:

1. Transactions with Owners

Any transactions directly involving the company's owners (shareholders) are never included in comprehensive income. This is because comprehensive income aims to reflect the performance generated by the company's operations and external factors, not changes in equity due to owner-related activities. Key examples include:

Issuance of Stock: When a company issues new shares of stock, it receives cash (or other assets) from investors. This increases equity, but it's a capital transaction, not an item of income or loss. The increase in cash and equity is recorded directly in the equity section of the balance sheet (typically in the Common Stock and Additional Paid-in Capital accounts).
Repurchase of Stock (Treasury Stock): When a company buys back its own shares, it reduces both cash and equity. This is also a capital transaction, not an income or expense item. The decrease in cash and equity is recorded directly in the equity section of the balance sheet as a reduction in treasury stock.
Payment of Dividends: Dividends are distributions of a company's accumulated profits to its shareholders. While they reduce retained earnings (a component of equity), they are not an expense and do not appear on the income statement or the statement of comprehensive income. They are a direct reduction of equity.
Stock Options Exercised: When employees exercise stock options, they purchase shares of the company's stock at a predetermined price. The company receives cash and issues new shares. This is a capital transaction similar to the issuance of stock and is recorded in the equity section of the balance sheet.
Share-based compensation: While the expense associated with share-based compensation (like stock options) is included on the income statement (and therefore, contributes to net income, which is part of comprehensive income), the actual issuance of shares upon exercise is a transaction with owners and not part of comprehensive income itself.

Why Exclude Owner Transactions?

The rationale for excluding these items is straightforward: they don't reflect the company's operating performance. They are purely financial transactions that alter the composition of equity but don't represent the effectiveness of management in generating profits or managing assets. Including them would muddy the waters and make it harder to assess the company's true financial health.

2. Prior Period Adjustments (with Exceptions)

Generally, corrections of errors made in prior periods are not included in the statement of comprehensive income. These adjustments are typically handled by restating prior period financial statements.

Accounting Errors: If a significant error is discovered in a prior period's financial statements (e.g., a mistake in revenue recognition, an incorrect depreciation calculation), the company must correct the error. This correction typically involves restating the affected prior period financial statements as if the error had never occurred. The cumulative effect of the error on prior periods' net income is adjusted directly to the beginning retained earnings balance in the statement of retained earnings (or the statement of changes in equity).

Exceptions to the Rule:

While most prior period adjustments are excluded, there are exceptions, particularly related to the retrospective application of new accounting standards.

Retrospective Application of New Accounting Standards: When a new accounting standard is issued, it often requires companies to apply it retrospectively, meaning they must restate prior period financial statements as if the new standard had always been in effect. The cumulative effect of applying the new standard to prior periods is usually adjusted to the beginning retained earnings balance in the statement of retained earnings. While not technically "comprehensive income," it's a necessary adjustment to ensure comparability across periods.

Why Exclude Most Prior Period Adjustments?

The primary reason for excluding most prior period adjustments from comprehensive income is to maintain the integrity of the current period's performance measurement. Including them would distort the current period's results by reflecting errors or changes related to past periods. Restating prior period statements provides a clearer and more accurate picture of the company's historical performance.

3. Transfers to and from Appropriated Retained Earnings

Some companies may choose to "appropriate" a portion of their retained earnings for a specific purpose, such as future expansion, debt repayment, or contingencies. This appropriation involves transferring a portion of retained earnings to a separate "appropriated retained earnings" account.

Appropriations of Retained Earnings: These appropriations are simply internal bookkeeping entries. They do not represent an expense or a loss, and they do not affect net income or comprehensive income. They are merely a way of earmarking a portion of retained earnings for a particular purpose. The transfer to and from appropriated retained earnings accounts only changes the composition of equity, not its overall amount.

Why Exclude Transfers to/from Appropriated Retained Earnings?

These transfers are excluded because they are internal allocations of equity, not transactions that reflect the company's operating performance or external economic factors. They don't represent a gain or loss and don't impact the company's overall financial position.

4. Unrealized Gains/Losses on Trading Securities

While unrealized gains and losses on available-for-sale securities are included in OCI, unrealized gains and losses on trading securities are not included in OCI.

Trading Securities: These are securities that a company purchases with the intent of selling them in the near term to profit from short-term price fluctuations. Unrealized gains and losses on trading securities are recognized directly in the income statement (as part of net income) in the period in which they occur. Because they flow through the income statement, they are already included in comprehensive income through the net income component. Therefore, including them again in OCI would be double-counting.

Why the Difference Between Trading and Available-for-Sale Securities?

The treatment differs because of the different investment strategies. Trading securities are held for short-term profit, so their gains and losses are considered part of the company's core operating activities. Available-for-sale securities are held for a longer term, so their unrealized gains and losses are considered less directly related to current operations and are therefore reported in OCI.

5. Changes in Fair Value of Certain Liabilities

Similar to the treatment of certain securities, changes in the fair value of certain liabilities, particularly those designated as fair value hedges, are generally not included in OCI.

Fair Value Hedges: Companies use fair value hedges to protect themselves from changes in the fair value of an asset or liability. The gains and losses on the hedging instrument (e.g., a derivative) and the hedged item are recognized in current earnings. This means that the impact of these changes is already reflected in net income and, consequently, in comprehensive income.

Why Exclude Changes in Fair Value Hedges?

Including these changes in OCI would again result in double-counting. The intent of a fair value hedge is to offset changes in the value of an asset or liability with changes in the value of the hedging instrument, and the net effect is already reflected in the income statement.

6. Items Specifically Excluded by Accounting Standards

It's important to recognize that accounting standards (like GAAP and IFRS) are constantly evolving. Therefore, specific items might be excluded from comprehensive income based on the latest pronouncements from standard-setting bodies like the FASB (in the US) or the IASB (internationally).

Staying Updated: Companies must stay abreast of these changes to ensure their financial statements are compliant and accurately reflect their financial performance. This often involves consulting with accounting professionals and carefully reviewing the latest accounting standards.

The Importance of Consulting Accounting Standards:

Accounting standards provide specific guidance on what should and should not be included in comprehensive income. Deviation from these standards can lead to inaccurate financial reporting and potentially mislead investors and other stakeholders.

Why Are These Exclusions Important?

Understanding these exclusions is critical for several reasons:

Accurate Financial Reporting: Excluding these items ensures that the statement of comprehensive income provides a clear and accurate picture of a company's financial performance, focusing on core operations and relevant external factors.
Improved Analysis: By focusing on operational performance and key OCI items, analysts and investors can better assess a company's profitability, risk exposure, and long-term value creation.
Enhanced Comparability: Consistent application of accounting standards regarding comprehensive income improves the comparability of financial statements across different companies and industries.
Better Decision-Making: Accurate and reliable financial information empowers stakeholders to make informed decisions about investing, lending, and other business activities.

Examples to Illustrate Exclusions

Let's consider a few simplified examples:

Example 1: Stock Issuance

A company issues 10,000 shares of stock at $20 per share. The company receives $200,000 in cash. This transaction increases cash and equity but is not included in the statement of comprehensive income. It's recorded directly in the equity section of the balance sheet.
Example 2: Dividend Payment

A company pays a cash dividend of $1 per share to its 1 million outstanding shares. The company's cash decreases by $1 million, and retained earnings decrease by $1 million. This is not an expense and is not included in the statement of comprehensive income. It's a direct reduction of equity.
Example 3: Prior Period Error Correction

A company discovers that it overstated its revenue in the prior year by $50,000 due to an accounting error. The company restates the prior year's financial statements and adjusts the beginning retained earnings balance in the current year by $50,000. This adjustment is not included in the statement of comprehensive income.
Example 4: Transfer to Appropriated Retained Earnings

A company decides to appropriate $100,000 of retained earnings for future expansion. It transfers $100,000 from retained earnings to an appropriated retained earnings account. This transfer is not included in the statement of comprehensive income. It's an internal allocation of equity.

Statement of Comprehensive Income: Presentation Formats

The statement of comprehensive income can be presented in two main formats:

Single Statement Approach: A single continuous statement that starts with net income and then presents the components of OCI, arriving at a total comprehensive income figure. This format is often favored for its simplicity and clarity.
Two-Statement Approach: Two separate, but consecutive, statements. The first is the traditional income statement, reporting net income. The second statement begins with net income and then presents the components of OCI to arrive at total comprehensive income.

Both formats are acceptable under accounting standards, but the single-statement approach is becoming increasingly popular.

The Future of Comprehensive Income Reporting

The reporting of comprehensive income continues to be a subject of debate and potential change within the accounting profession. One ongoing discussion revolves around which items should be included in OCI and whether certain items should be "recycled" out of OCI into net income when they are realized. This recycling issue is particularly relevant for items like gains and losses on available-for-sale securities.

The goal of these discussions is to improve the relevance and usefulness of comprehensive income information for investors and other stakeholders.

Conclusion

The statement of comprehensive income provides a more complete picture of a company's financial performance than a traditional income statement. However, it's crucial to understand what items are excluded from this statement to accurately interpret the information it presents. Transactions with owners, most prior period adjustments, transfers to/from appropriated retained earnings, unrealized gains/losses on trading securities, and changes in fair value of certain liabilities are generally not included. By understanding these exclusions, users of financial statements can gain a deeper insight into a company's true financial health and performance. Keeping up-to-date with evolving accounting standards is essential to ensure accurate and compliant reporting.