Comprehensive income
This chapter follows US GAAP (ASC 220, Income statement - reporting comprehensive income) and the FASB Concepts Statements to explain what comprehensive income is and how it’s presented.
Comprehensive income
The term comprehensive income is defined as the changes in net assets (equity) of a company coming from transactions and events other than those related to the owners.
Transactions with owners are not considered as part of comprehensive income. These transactions with owners include the elements discussed in the balance sheet:
- investments from owners
- distributions to owners
All other transactions and events that change net assets (equity) - not merely assets or liabilities, since borrowing cash changes both without changing equity - are part of comprehensive income.
To simply illustrate this, let’s take a company that received $500. The treatment of this depends which party the cash was received from:
The comprehensive income of an entity is composed of two subtotals:
- Net income
- Other comprehensive income (OCI)
Net income is composed of four elements: revenues, expenses, gains, and losses. OCI does not have these elements - instead, it consists of transactions specifically identified by US GAAP. Common OCI items include unrealized gains and losses on available-for-sale (AFS) debt securities, foreign currency translation adjustments, and certain pension and postretirement benefit adjustments. The next chapter, Discontinued operations and other comprehensive income (OCI), covers these items in detail.
Here’s how comprehensive income is presented as a financial statement.
Presentation of comprehensive income
A company has two options to report comprehensive income and its components:
Option 1: Single continuous financial statement
This option requires the company to present comprehensive income using one continuous financial statement called the statement of comprehensive income that is separated into two general sections:
- net income section
- other comprehensive income section
Each section should be further broken down into line items that provide information of the source or nature of each item.
A sample continuous statement of comprehensive income is presented below:
Option 2: Two separate but consecutive financial statements
This option requires the company to present the comprehensive income using two separate financial statements:
- Income statement - this separate financial statement gives details of the revenues, expenses, gains and losses of the company that are added together to form a singular net income for the period.
- Statement of comprehensive income - this financial statement starts with the amount of the net income from the income statement. Then the components of OCI are added together to form a singular comprehensive income for the period.
If a company has no OCI items in any period presented, it only needs to present the income statement - the statement of comprehensive income isn’t required.
A sample of the two consecutive financial statements are presented below:
The net income
Net income is the portion of comprehensive income that reports non-owner changes in equity through four elements:
- revenue
- expenses
- gains
- losses
The remaining non-owner changes in equity - those not captured by revenues, expenses, gains, or losses - are reported in other comprehensive income (OCI).
The amounts in the income statement should be read and analyzed with the period in mind since the elements of the income statement are presented for “a period of time”.
For example, the net income can be presented for a 12-month period (this means that the revenues presented are the ones earned for the 12-month period covered by the statement) or quarterly basis (this means the revenues presented are only for a specified three-month period). Understanding this will help users of the financial statements better compare results to other companies or to previous periods.
Generally the elements of the income statement are recorded using the accrual method which means that:
- Revenues and income are recorded when they are earned regardless of when cash was received.
- Expenses and losses are recorded when they are incurred regardless of when cash was paid.
1. Revenues
These are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities. These include routine transactions as well as “other activities” - such as permitting others to use the entity’s resources - that result in interest, rent, royalties, and fees.
According to the GAAP revenue recognition principles, revenues are earned and recognized in the period when the performance obligation is satisfied.
2. Expenses
These are outflows or other using up of assets of an entity or incurrences of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities. These include routine transactions as well as “other activities” - such as the entity using the resources of others - that result in interest, rent, royalties, and fees paid.
The expense recognition principle, or the matching principle, states that recognition of expenses is related to net changes in assets and the earning of revenues. Expenses should be recognized when the work or product contributes to revenue.
3. Gains
These are increases in equity (net assets) from transactions and other events and circumstances affecting an entity except those that result from revenues or investments by owners.
4. Losses
These are decreases in equity (net assets) from transactions and other events and circumstances affecting an entity except those that result from expenses or distributions to owners.
Distinguishing between revenue, expenses, gains, or losses
Distinguishing revenues from gains, and expenses from losses, helps users assess the amount, timing, and uncertainty of future cash flows by separating routine transactions from other events.
While revenues and expenses typically result from delivering or producing goods, rendering services or carrying out other activities, gains and losses typically result from one of the following three circumstances:
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Nonreciprocal transactions or events, such as natural catastrophes, which are clearly distinguishable from revenues and expenses.
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Exchange transactions - whether an item is revenue or a gain depends on the nature of the entity and the activity the item is associated with. For example, the proceeds from selling a machine held as inventory are revenue, and the machine’s cost is an expense. But the proceeds from selling a machine the entity used in its own operations are not revenue - the entity reports a gain or loss on disposition instead.
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Holding gains and losses - changes in the value of assets or liabilities that the entity holds, as opposed to sells. Value changes from the passage of time under a contract (e.g., interest) are usually revenue or expense. Changes in market value (e.g., a rise in an investment’s fair value) are usually gains or losses.
Example: from net income to total comprehensive income
Achievable Co. reports net income of $120,000 for the year. It also recognizes a $5,000 unrealized gain on AFS debt securities, a $2,000 foreign currency translation loss, and a $500 pension adjustment loss - all OCI items under US GAAP.
- Other comprehensive income (OCI): $5,000 − $2,000 − $500 = $2,500
- Total comprehensive income: $120,000 + $2,500 = $122,500
Answer: total comprehensive income is $122,500, combining net income with the net OCI for the period.