BEFORE January 1, 2009, a complete set of financial statements prepared in accordance with International Financial Reporting Standards (IFRS) comprised the following: a balance sheet, an income statement, a statement of changes in equity, a cash flow statement, and notes to the financial statements. When amendments to International Accounting Standards (IAS) 1, Presentation of Financial Statements took effect for annual reporting periods beginning 1 January 2009, the statement of comprehensive income (SCI) was introduced, and became part of an entity’s financial statements. This resulted from the International Accounting Standards Board’s (IASB) efforts to continuously improve financial reporting.
The SCI is seen as a performance statement showing all changes in net assets, except capital contributions and return of capital. Such changes are regarded by the IASB as a measure of ‘performance’ in its widest sense. The SCI does not feature the net income or loss, but instead the total comprehensive income or loss, which is defined by IAS 1 as “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”. Total comprehensive income includes both profit or loss and OCI. Requiring the SCI highlighted both the IASB’s and public’s increasing focus on the concept of Other Comprehensive Income (OCI).
WHAT IS OCI?
OCI contains items of income and expenses that are recognized outside of the income statement or the profit or loss. It is driven by specific IFRS provisions or requirements. Some common examples of OCI items are:
• Gains or losses on remeasuring available-for-sale (AFS) financial assets to fair value;
• Changes in revaluation surplus for items of property, plant and equipment or intangible assets that are carried using the revaluation method;
• Remeasurements of defined benefit retirement plans;
• Gains or losses arising from translating the financial statements of a foreign operation;
• The effective portion of gains or losses on hedging instruments in a cash flow hedge.
OCI is required to be presented separately in the equity section. This is done to increase the transparency of these items as users can easily distinguish them from those items presented as part of profit or loss.
IAS 1 does not define ‘income’ or ‘expenses’. The Conceptual Framework for Financial Reporting defines income and expense, but does not provide guidelines on distinguishing which should be presented as the traditional profit or loss and which should be presented as OCI. What this means is that profit and loss is the default category -- all comprehensive income is part of profit and loss unless a provision of IFRS say it is or may be OCI.
In terms of classification, there are two general types of OCI: those that can be reclassified (or ‘recycled’) to profit or loss in future periods, and those that are not allowed to be reclassified to profit or loss. Both types and their related movements must be separately shown or disclosed either in the SCI or in the notes to financial statements. Gains or losses on remeasuring AFS financial assets to fair value are OCI examples that are recycled to profit or loss when the related assets are sold or become impaired, while changes in revaluation surplus and remeasurements of defined benefit retirement plans are examples of those that are not allowed to be recycled to profit or loss.
This separate presentation enables users of the financial statement to ascertain the impact of the reclassifications on the profit or loss and the overall gain or loss from a certain transaction such as the sale of AFS financial assets.
A SINGLE STATEMENT OR TWO STATEMENTS?
Entities are given the option to present all these OCI items in a single SCI, or in two linked statements, i.e., a separate statement of income and a separate SCI. In a single-statement approach, all items of income and expenses are presented together. In a two-statement presentation, the first statement -- the income statement -- presents income and expenses recognized in profit or loss, while the second statement -- the SCI -- begins with profit or loss, adds or deducts all the items of OCI (net of the related taxes) and ends up with total comprehensive income.
There are varying opinions on the better presentation. Those who prefer the two-statement approach want to distinguish profit or loss and total comprehensive income. They point out the following rationale:
• With the two-statement approach, the income statement remains a primary financial statement.
• A single statement would undermine the importance of profit or loss by making it a subtotal.
• Presenting total comprehensive income as the last number in the statement would confuse users.
Proponents of the two-statement approach fear that requiring all items of income and expenses to be presented in a single statement would be the first step towards eliminating the notion of profit or loss. In addition, they argue that the items that are presented in OCI are different from the items presented in profit or loss.
The proponents of the single-statement approach argue that all items of non-owner changes (both P&L and OCI) in equity actually meet the definitions of income and expenses in the Conceptual Framework for Financial Reporting (the Framework). The Framework neither defines profit or loss, nor provides the criteria for distinguishing the characteristics of items that should be included in profit or loss from those items that should be excluded from profit or loss.
The IASB emphasized that both profit or loss and total OCI remain equally important and prominent in assessing an entity’s financial performance. Currently, however, the main key performance indicator of most entities remains the profit or loss before OCI. Even in the calculation of the earnings per share, profit or loss (or net income) remains the required starting point for the calculation of earnings per share.
Looking forward, the IASB is considering working on a conceptual framework for OCI to set out a conceptual basis for how an entity determines whether an item should be presented in OCI or in profit or loss, and the principles to determine which OCI items should, or should not be, reclassified to profit or loss. Given how financial reporting standards are constantly changing and evolving with the thrust moving forward to fair valuation basis of accounting, resulting to more and more income items being considered as OCI rather than the “regular” profit or loss items, total comprehensive income may someday become the key performance metric for entities.
Jennifer D. Ticlao is a Partner of SGV & Co.
source: Businessworld
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