Despite regulators granting relief to corporations from having to fully disclose additional revenue and expenses on income statements, CFOs and other senior executives might still be tripped up by future income-reporting requirements.
Other comprehensive income (OCI), or the expenses, revenue, or gains and losses left out of net income, has become a sticking point for many corporations.
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have collaborated to address reporting and disclosure requirements for the OCI. The idea was to align U.S. GAAP and international financial reporting standards (IFRS) financial-statement reporting by prominently displaying the OCI on both of those financial statements in addition to addressing the differences in the definition and disclosure of the OCI by the two standards-setters.
Last June FASB issued an updated standard on the OCI disclosure requirements. One requirement directed companies to present net income and the OCI in either one single continuous statement or as two separate, but consecutive, statements of net income and comprehensive income. For most companies this change was somewhat cosmetic, moving the OCI from the back of the income statement, where it was previously disclosed in footnotes, to the front of the statement. Further, the update dropped the requirement to report the OCI in the statement of changes of shareholder’s equity.
Gaylen Hansen, a partner at Ehrhardt Keefe Steiner & Hottman PC, an accounting firm based in Denver, believes the new standard is a reasonable improvement in both presentation and uniformity of application by removing at least one option: “Consequently, linking OCI to the income statement makes a lot more sense than jamming it into the equity statement.”
Similarly, Hans Hoogervorst, chairman of the IASB, said at the annual IFRS Taxonomy Conference last April that financial reporting should not get stuck on the issue of whether the OCI is reported on the same or different statements. Financial reporting in the 21st century is more complex than that, he said.
The second part of the updated standard, which is more controversial, requires the reclassification of adjustments, or what is commonly called in the industry as “recycling,” from Accumulated Other Comprehensive Income (AOCI) to the income statement. The adjustments must be measured and presented by line item in the income statement. Recycling of the OCI adjustments occurs when they are booked to the income statement to record the reclassifications.
Companies with complex OCI components would likely be required to prepare a tabular statement showing the adjustment detail in the one- or two-part net income and the OCI statement. For example, a manufacturing company that allocates pension expense to manufacturing cost pools that are capitalized to inventory would need to break out the allocation to the OCI statement by expense line item.
Comment letters to FASB raised concerns about the lack of guidance to identify the line-item detail, the reporting burden that would be imposed by the requirement, and the potential confusion the disclosure might cause financial-statement users. For example, James G. Campbell, Intel Corp.’s vice president, finance corporate control, wrote in a comment letter to FASB, “We believe that the income statement should be clear and concise, so that a company’s financial performance can be readily measured. Adding reclassifications to our income statement could increase the number of line items by up to 50 percent in a period, depending upon materiality.”
FASB responded to this and other comments by deferring the OCI recycling disclosure requirement by issuing an amendment to the updated standard in December 2011. The rule became effective for public companies for fiscal years (including interim periods) beginning after December 15, 2011. Nonpublic companies must comply for their first full fiscal year-end 2012 statements.
In preparing those statements, CFOs and other executives could face reporting requirements relating to aggregating the OCI or the AOCI. Depending on the complexity of a company’s AOCI adjustments, it could turn into a substantial incremental reporting burden. For example, enterprise resource planning systems, which integrate a company’s departments, may need to be modified to accommodate identifying net income and the AOCI statement adjustments. Additional components of the OCI may also be added to the reporting table.
The IASB and FASB have not resolved all of the issues relating to the OCI. In part of its board meeting today, for example, FASB is looking into whether changes are necessary for the presentation requirements for reclassification out of the AOCI. As we move toward accounting convergence, more disclosure requirements may also be demanded.
For some, the requirements may not be too taxing. Paul W. Karr, senior vice president and deputy controller of American Express, says that while his company would probably not face an undue burden from the disclosure requirements, he concedes that manufacturers might face serious compliance challenges. He nevertheless backs the involvement of the IASB and FASB, and gives “[FASB and the] IASB credit for listening to the concerns from preparers about the provisions of the OCI update requiring disclosure of reclassifications on the income statement.”
But Ehrhardt Keefe Steiner & Hottman’s Hansen notes that users are going to need some time to get used to the new requirements, and he does not favor removing any of the significant disclosures rules anytime soon. “OCI still is not widely understood. We see blatant errors all the time in the interaction of OCI between reporting financial position and results of operations.”
Remember that the OCI, the AOCI, and the related adjustments may be inherently risky. CFOs should strive to implement clear and transparent reporting systems to monitor and measure OCI risks regardless of accounting standards. Effectively understanding the OCI is, after all, about taking into consideration the meaning of the components on an income statement and a company’s ability to report them transparently and accurately.