Other comprehensive income

Other comprehensive income comprises items of income and expense (including reclassification adjustments) that are not recognised in profit or loss as required or permitted by other IFRSs.

IFRS in respect of the classification of gains or losses in other comprehensive income or profit or loss/profit and loss is directed by the notion that all gains and losses that are not defined as a component of other comprehensive income are by definition part of profit or loss.

All components of ‘profit or loss’ and of ‘other comprehensive income’ are summarised as ‘Total comprehensive income’. Total comprehensive income is the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners.

The components of other comprehensive income include:

  1. changes in revaluation surplus (see IAS 16 39 Property, Plant and Equipment and IAS 38 85 Intangible Assets);
  2. remeasurements of defined benefit plans (see IAS 19 57(d) Employee Benefits);
  3. gains and losses arising from translating the financial statements of a foreign operation (see IAS 21 30 – 33, IAS 21 39(c) The Effects of Changes in Foreign Exchange Rates);
  4. gains and losses from investments in equity instruments designated at fair value through other comprehensive income in accordance with paragraph 5.7.5 of IFRS 9 Financial Instruments;(da) gains and losses on financial assets measured at fair value through other comprehensive income in accordance with paragraph 4.1.2A of IFRS 9.
  5. the effective portion of gains and losses on hedging instruments in a cash flow hedge and the gains and losses on hedging instruments that hedge investments in equity instruments measured at fair value through other comprehensive income in accordance with paragraph 5.7.5 of IFRS 9 (see Chapter 6 of IFRS 9);
  6. for particular liabilities designated as at fair value through profit or loss, the amount of the change in fair value that is attributable to changes in the liability’s credit risk (see paragraph 5.7.7 of IFRS 9);
  7. changes in the value of the time value of options when separating the intrinsic value and time value of an option contract and designating as the hedging instrument only the changes in the intrinsic value (see Chapter 6 of IFRS 9);
  8. changes in the value of the forward elements of forward contracts when separating the forward element and spot element of a forward contract and designating as the hedging instrument only the changes in the spot element, and changes in the value of the foreign currency basis spread of a financial instrument when excluding it from the designation of that financial instrument as the hedging instrument (see Chapter 6 of IFRS 9);
  9. insurance finance income and expenses from contracts issued within the scope of IFRS 17 Insurance Contracts excluded from profit or loss when total insurance finance income or expenses is disaggregated to include in profit or loss an amount determined by a systematic allocation applying paragraph 88(b) of IFRS 17, or by an amount that eliminates accounting mismatches with the finance income or expenses arising on the underlying items, applying paragraph 89(b) of IFRS 17; and
  10. finance income and expenses from reinsurance contracts held excluded from profit or loss when total reinsurance finance income or expenses is disaggregated to include in profit or loss an amount determined by a systematic allocation applying paragraph 88(b) of IFRS 17.

Background

Other comprehensive income (OCI) has, long before the concept was implemented in the financial statements, been widely discussed among as well standard setters as producers and users of financial information. The discussion has mainly evolved around the value relevance of OCI and how the concept should practically be used and interpreted.

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Much discussion has concerned whether net income or total comprehensive income (TCI) should constitute the “bottom line” (Dhaliwal, D., Subramanyam, K. R. and Trezevant, R. 1999, 43-67) but from the producers’ point of view, the discussion has revolved around the vaguely defined standards controlling OCI (Rees, L. L. and Shane, P. B. 2012, 789-815). The standard controlling OCI was revised 2007 (implemented 2009) with an aim to clarify the concept.

Mid 2011, the International Accounting Standards Board (IASB) launched its first public consultation aiming to explore what stakeholders wanted the IASB to prioritize in the future (IASB, 2011a). After the collection of respondents, it was possible to draw the conclusion that, among others, OCI was a concept in need for discussion. Two commonly expressed views were: “(…) OCI is perceived as a ‘dumping ground’ for anything controversial” and “many users of financial statements ignore changes reported in OCI” (IASB 2013, 150).

In 2013, the IASB issued a discussion paper regarding, among other things, OCI. One of the objectives with the discussion paper was to understand how different stakeholders perceived OCI and their attitude towards the current way of reporting profit or loss and OCI. The IASB is aiming to introduce a revised version of the Conceptual Framework in 2015 (IASB 2013, 14), and the presentation of OCI is anticipated to be a focus area.

Do reporting entities perceive OCI as a useful concept in practise?

The two most fundamental financial accounts are the statement of financial position and the statement of profit or loss. The latter is often used as the number one report to predict future cash flows but ever since the concept OCI was introduced, there has been much discussion regarding how to report income. The discussion arose based on the traditional view that only realized profits should be included as earnings in the statement of profit or loss. There are mainly two issues arising from this view. First, the definition of “what is realized” is vague.

Secondly, value changes, beside such that are realized, may have occurred (due to macroeconomic factors as an example) during the period and, according to fair presentation, these changes should be presented. These gains or losses, are all part of, and presented as, comprehensive income (CI) (Schroeder, R. G., Clark, M. W. and Cathey, J. M. 2005, 183).

The stated purpose of CI is to report all changes in equity that result from transactions other than such with owners (IAS 1.7). When used with other related accounting information, CI aims to help assessing future cash flows and hence evaluate performance (Schroeder, R. G., Clark, M. W. and Cathey, J. M. 2005, 183). Nevertheless, more focus is directed to the statement of profit or loss. The reason might be that only realized profits are viewed as reliable earnings estimates and these are mainly presented in the statement of profit or loss (Alexander, D. and Nobes, C. 2010, 101-108). The relationship between profit or loss and OCI can be explained as: net income + OCI = TCI.

Recycling

The revised IAS 1 (implemented 2012) requires presentation of which OCI-items that are to be reclassified to the statement of profit or loss. Items that, in the future, may be recycled to profit or loss must be presented separately from those items that will not be recycled (IAS 1 92). This revision simply changed the presentation of OCI, it did not change the nature of items or whether reclassification will occur or not. This change assists users of accounting to more easily assess how future earnings will be affected (EY 2012, 12).

When value changes, previously included in OCI, are realized, they are included in profit or loss. When realized, the item is deducted from OCI and instead included in profit or loss (IAS 1.93). Reclassification adjustments arise on disposal of foreign operation, derecognition on available-for-sale financial assets and when a hedged transaction affects profit or loss (IAS 1.95). Adjustments do not arise on revaluation surplus or actuarial gains or losses on defined benefit plans (IAS 1 96).

Connection to Equity and to the Statement of Changes in Equity

OCI constitutes all changes in equity resulting from all other transactions than those with owners. A negative OCI means a decrease in equity and vice versa (IAS 1). In this way, the statement of OCI extends the statement of profit or loss and acts as a complement to the statement changes in equity. The statement of changes in equity and CI complement each other in the way that they show all transactions with owner’s equity (Smith, B. P. 2010, 98).

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Importance of profit or loss

Generally, there seem to be concurrence among the respondents that profit or loss is the most important performance measure, thus should be remained as a total or subtotal. Even though, if markets were efficient, there would be no need to present a subtotal (Berk, J. and DeMarzo, P. 2011, 450) but however, research has shown that the presentation of TCI has an impact on users ability to interpret the information (Hirst, E. and Hopkins, P. 1998, 47-75 & Chambers, D. et. al. 2007, 557-559). Many respondents have used the same phrases as the IASB in their discussion paper, such as “’profit or loss’ (…) is deeply ingrained in the economy, business and investors’ minds.”.

The IASB’s view is that profit or loss is an important figure and consequently they believe that it should be remained as a total or subtotal measure. However, the IASB is unwilling to define “financial performance” due to their argument that “all items recognised in the statement(s) of profit or loss and OCI provide some information about financial performance. (…) this Discussion Paper does not equate financial performance with either ‘total comprehensive income’ or ‘profit or loss’ or with any other total (…)”.

Many respondents have commented upon this as something strange. Indubitably, it seems likely that a measure – such as profit or loss – that has been used over a long time period as “the bottom line” – is ingrained in the business community and investors’ minds. However, without defining “financial performance” and by default require that profit or loss should be kept as a total or subtotal it could be interpreted that the IASB still consider profit or loss as the (sub)bottom line.

Yet, defining a universal meaning for “financial performance” is a difficult task. This issue is also discussed by Hirst and Hopkins. They explain that there is a way for management to get around the standard, to present desirable results, but that a clear definition of accounting standards would prevent this (Hirst, E. and Hopkins, P. 1998, 47-75).

Although the IASB discusses several arguments in favour for not keeping profit or loss as a total or subtotal (such as focusing on profit or loss makes users of financial reports overlook OCI) the question regarding this issue is posed in a manner that we have interpreted it as the respondents have been forced to answer whether profit or loss is good or not. All respondents agreed in one way or another upon the IASB’s view that profit or loss should be kept as a total or sub-total.

Unfortunately, this does not tell us that OCI is lacking of significance or practical usefulness, however it does tell us that profit or loss is a seemingly perceived useful concept, which could partly be explained by the fact that it has been used as the “bottom line” in the statement for profit or loss for a long time period. Hirst and Hopkins even argue that investors fail to analyse information given outside profit or loss (Hirst, E. and Hopkins, P. 1998, 47-75).

“Treating profit or loss as a ‘default category’ is wrong!”

In the discussion paper, the IASB has chosen an approach to profit or loss which they state is a “default category-approach”. That is, they have chosen to define what items could be recognised in OCI (and not those that could be recognised in profit or loss) and as a consequence they treat profit or loss as the “default category” (which they claim to be in line with current IFRS) (IASB 2013, 158).

Except for one respondent that states that “profit or loss should be the default location (…) IFRS as a whole indirectly defines profit or loss by defining which transactions should be reported outside profit or loss”, approximately half of those that responded question 19 have strongly opposed this. Glyn Parry, a director within group financial control at BT Group PLC, expressed a view that we believe is representative for many of those that opposed “the default category”, namely by stating:

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“We are not convinced about the appropriateness of the IASB’s general approach to OCI. We believe that in order to support the IASB’s conclusion on what items should be recognised as part of OCI, the IASB should first specify what items of expense and income should be recognised in the income statement.

This should be achieved though a definition of performance and establishing that the income statement is the primary measure of an entity’s performance. We believe that the definition of performance should be closely linked to a company’s business model and the primary value-generating activities of the company” (comment letter #146)

As touched upon in earlier, many respondents, Glyn Perry included, have indicated that the IASB should define performance. Again, this is something that has been discussed by Rees and Shane (2012, 789-815). However, when opposing profit or loss as the default category, many respondents argue that the IASB should establish the statement of profit or loss to be the primary source of information in regards of a company’s performance.

Even if the producers of OCI believe that the statement of profit or loss should be the primary source of information, it does not necessarily contradict that the information in OCI is not valuable. What it might just tell us is that producers of OCI believe that OCI provides a secondary source of information.

This would also be in line with the IASB’s view that both profit or loss and OCI provide some information in regards of the entity’s performance (IASB 2013, 154). However, this somehow contradicts to what Godfrey. et. al. (2010, 429) concluded – that there is a trend towards a single bottom line including all relevant information.

By separating OCI into items that may be reclassified to profit or loss and items that will not be reclassified, producers of OCI believe they will achieve the fairest presentation

Out of the 21 respondents that answered question 21, 15 clearly stated that they prefer approach 2B. That is, more than 70% of these respondents seem to appreciate the current technique on how to report OCI. Unfortunately, we were not able to attain as exhaustive answers as originally hoped – the absolute majority out of the 70% “agreed” without any reasoning – this makes us unable to draw accurate conclusions. The comments were rather indistinct, such as proposing the IASB to rephrase certain items to give one example.

However, several respondents expressed that by using a broader approach, there will be greater flexibility (the word “flexibility” was used in numerous comment letters) which also allows for certain value changes, such as actuarial gains and losses, to be held outside the statement of profit or loss. As this does not contradict with the current standard, one may interpret that producers are satisfied with the current presentation of OCI. However, we cannot conclude that this is the reality.

To exemplify: the one respondent that stated that they thought OCI as a concept should be eliminated and “think[s] the solution is to fundamentally rethink the structure of the profit or loss statement and to abolish the OCI”, still agrees that the broad approach is preferable. That is, in this specific comment letter, the broad approach seemed like the preferred approach – when actually they believe that OCI as a concept should be abolished.

See also: Conceptual Framework 2018

Other comprehensive income

Other comprehensive income

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