- Other comprehensive income must now be reported on income statements.
- FASB amends 1996 rule that allows other comprehensive income to appear in statements of changes in equity.
- Academic research revealed that analysts overvalued companies when other comprehensive income information was less prominently displayed.
- Other comprehensive income information may illuminate practice of managing earnings.
In June, the Financial Accounting Standards Board (FASB) announced a rule change that requires companies to report the elements of their other comprehensive income on the income statement, just beneath the report of net income. This requirement puts other comprehensive income in a more prominent location in a financial statement that was previously required.
“We heard from investors there was a need to present other comprehensive income information more prominently in financial statements,” said Leslie F. Seidman, chairwoman of the FASB, in a statement that accompanied the rule change in June. The change eliminated the option for companies to report comprehensive income in the statement of changes in equity.
Since 1996 FASB, which sets financial reporting standards for U.S. companies, required that comprehensive income be disclosed in company financial statements. But the rule-makers were less specific about where in the statements other comprehensive income had to be reported.
Other comprehensive income is typically more volatile than net income reported on a company’s financial statement. Pension assets and liabilities, derivatives, marketable securities and other assets and liabilities are among the items that may change in value day to day and can’t be pinned down until they are sold, at which point they are included on the income statement. The strategic timing of these sales, which may affect a company’s net income for the statement period, is known as managing earnings.
Eric Hirst, the John Arch White Professor of Business at the McCombs School of Business, with co-author Patrick Hopkins of Indiana University, published a study in 1998 that demonstrated the format of financial statements issued by companies affects whether professional securities analysts detect companies’ earnings management activities. Earnings management is a common yet controversial accounting practice used by companies to produce a desired financial appearance by, for example, strategically timing gains or losses from sales of financial assets to produce rising earnings.
“The information that tells you, ‘this is smoke and mirrors,’ is not in an obvious place, and these securities analysts — who, this is what they do for a living — get fooled,” Hirst said. When that same information was more clearly displayed on the performance statement, the analysts quickly realized, “those earnings per share are going up because they’re timing the sale of those securities.”
This study, which has been heavily cited in other research articles, helped inform the recent rule change.
“Patrick and I can demonstrate a direct link between our work and the changes the FASB instituted — changes that affect every company that follows U.S. GAAP [generally accepted accounting principles],” Hirst says.
In the video, Hirst explains the rule change and how his study made an impact.