The Relevance of Comprehensive Income - Research Paper Example

Introduction One of the fundamental issues in setting accounting standards since 1930s has been an all–inclusive income measurement’s concept. Accounting standard setting bodies have constantly had the challenge of measuring an economic entity’s income as well as its financial position. Financial statements are the ultimate product of the accounting process. They are the main tools in transmitting the information to financial information users including creditors and stockholders among others to aid them in decision-making. The theory of competition forms the basis for market efficiency whereby prices are competitively set and decisions mirror the economic information available. Financial statements information is one category of economic information utilized in the promotion of market efficiency, the primary catalysts in the assembly and dissemination of such information being financial analysts. Difficulty in locating economic information or inconsistency in its presentation among companies results in inability of analysts in executing their role optimally. Additionally, there is efficiency breakdown, which was in existence prior to the introduction of comprehensive income statement for certain comprehensive income items directly included in stockholders equity (Smith & Reither, p14-20). According to statement NO 6 ‘Elements of financial statements’ of Financial Accounting Standards Board 1985 (FASB), comprehensive income is the change in a business enterprise’s equity during a period from transactions plus other circumstances as well as events apart from those stemming from distributions to and investments by owners. In other words, comprehensive income includes all non-owner changes in equity – this is contrary to net income, which fails to include some changes in equity (Harvey, para1). Comprehensive income attempts to measure the total of all financial and operating events that have adjusted the worth of an owner's interest in a business. Its measure is on a per-share basis to capture options’ and dilution’s effects. It cancels out equity transactions’ effects for which the owner would be indifferent including payments of dividend, share buy-backs as well as share issues at market value. Good examples of incidents that aid in shaping the nature of comprehensive income include profit or loss realized by property sale, alterations in operating expenses as well as any other transaction that is normally uncategorized as net income (Tatum, para1). Harvey documents that in 1997, Financial Accounting Standards Board issued the Statement of Financial Accounting Standard No. 130 (SFAS, 130), ‘Reporting Comprehensive Income’. The statement necessitates the disclosure of net income as well as a more comprehensive measure of income for financial years commencing after 15 December 1997. SFAS, 130 stipulates that four items, which under previous FASB pronouncements were recorded as owners' equity, be recorded in comprehensive income. These items include foreign currency translation adjustments (SFAS, 52), changes in market values of certain future contracts as hedges (SFAS, 80), minimum required pension liability adjustments (SFAF, 87), and adjustments to unrealized losses and gains on marketable securities that are available for sale (SFAS, 115). The purpose of issuing comprehensive statement, a measure of firm performance, is to make firms to reveal some certain elements of financial performance that would be helpful to financial reports’ user groups in making better evaluation on financial performance. As a basic financial statement, comprehensive income should report in details all the recognized expenses and revenues of the firm. The focus of income statement is normally on the operating expenses and revenues. Since financial reports’ user groups require data related to all expenses and revenues including losses and profits, a basic financial statement that will include such items in addition to showing changes in owners equity that are related to those items is necessary. Supporters of the "all-inclusive concept" hold the argument that as compared to other summary income measures, comprehensive income statement provides better firm performance measures. Conversely, advocates of ‘current operating performance’ are for the view that without inclusion of nonrecurring and extraordinary items, net income got better ability to reflect future cash flows of the firm (Robinson, p107-112). In the assessment of the current value of interest of an owner in the company, an excellent way is measuring income using the comprehensive income model. That is owing to the fact that taking measurements of a comprehensive income are on a basis that breaks down the events and transactions in a manner that reveals the impact on each share in the owner’s control. In this sense, comprehensive income aids in defining the status of the owner’s equity in the business (Tatum, para2). Tatum notes that the use of this model aids in the identification of the impact that any diluting factors have on a company’s status as well as the equity that shareholders have in the business. The use of a basic formula in the determination of comprehensive income in addition provides an explicit snapshot of the way the company has fared since the previous analysis. Moreover, the approach makes identifying an increase or decrease very straightforward as comprehensive income involves just comparing the book value per share at the end of the current period to the book value at the end of the last period. Worthy to mention is the fact that noting a reduction in book value per share does not necessarily signify that the company is in financial hitch. From one period to the next, some downward and upward movement in comprehensive income is probable. In fact, comprehensive income for most firms is more volatile whereby in some years, it exceeds net income while in others it falls below net income. Nonetheless, if the general trend for several periods is a decrease in the level of comprehensive income, this indicates that the company’s operation needs to address some issues (Tatum, para4). Conclusion Comprehensive income is a shift in a company’s net assets attributable to events outside the owners’ control. It is through comprehensive financial statements that firms reveal some certain elements of their financial performance. User groups of financial reports find them very helpful in making better evaluation/measuring the financial performance of a firm. Although there has been an extensive debate on the relevance of comprehensive income, there exist little empirical studies on the issue. Works Cited Harvey, C. R. (2004). Comprehensive Income. Retrieved 9th July, 2010 from http://financial-dictionary.thefreedictionary.com/Comprehensive+Income Robinson, L. E., (1991). The Time has come to Report Comprehensive Income. Accounting Horizons, 5, p107-112. Smith, P. A. & Reither, C. L. (1996). Comprehensive Income & the Impact of Reporting it. Financial Analysts Journal, 52, p14-20. Tatum, M. (2010). What is Comprehensive Income? Retrieved 9th July, 2010 from http://www.wisegeek.com/what-is-comprehensive-income.htm Read More