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17/01/2021 10:19:56 PM

Alternative Income Classifications and Measures (Part 3)

C. Comprehensive Income

GAAP has long espoused the comprehensive, or all-inclusive, concept of income, where the bottom-line income number articulates with equity in successive balance sheets-that is, the bottom-line income reflects all changes in shareholders’ equity aris­ing from other than owner transactions. This articulation is called clean surplus. Never­theless, standard setters have over time allowed certain components of comprehensive income to bypass the income statement as direct adjustments to equity. These adjust­ments, called dirty surplus; have increased in importance and magnitude in recent years. The motivation for these dirty surplus items comes from concerns about excessive income volatility if all changes to equity flow through the income statement. Still, many users are concerned that allowing changes to equity to bypass the income statement will reduce the reliability of accounting income. To address these concerns, companies are required to report a measure of comprehensive income in addition to net income.

Measuring Comprehensive Income.

Comprehensive income is computed by adjusting net income for dirty surplus items, collectively called other com­prehensive income. The other comprehensive income for this company consists of four components: (1) unrealized holding gains or losses that result from changes in the fair (market) value of available-for-sale investment securities, (2) foreign currency translation gains and losses, (3) changes in the funded status of postretirement benefits not included in net income, and (4) unrealized holding gains or losses arising from the effective portion of cash flow hedges (derivatives). These amounts are expressed on an after-tax basis. All four components are in the nature of unrealized (holding) gains or losses. The compo­nents arise from changes in the value of assets and liabilities that do not originate from arm’s-length transactions. A few analysts maintain that the transaction basis of net income is an important distinction between net income and comprehensive income. We show that this distinction is neither important nor necessarily true.