EARNINGS ANALYSIS AND OTHER COMPREHENSIVE INCOME
The last section in the AK Steel Holdings income statement in Exhibit 2.9 is devoted to the reporting of other comprehensive income. This is a relatively new feature of the income statement and was introduced with the issuance by the FASB of SFAS No. 130, Reporting Comprehensive Income. The goal of the standard is to expand the concept of income to included selected items of nonrecurring revenue, gain, expense and loss. Under the new standard, traditional net income is combined with a new component, “other comprehensive income,” to produce a new bottom line, “comprehensive income.”
The principal elements of other comprehensive income are listed in the other comprehensive income section of the AK Steel Holdings comprehensive income statement (Exhibit 2.9). They include:
1. Foreign currency translation adjustments.
2. Unrealized gains and losses on certain securities.
3. Minimum pension liability adjustments.
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Each one of these items was already recognized prior to the issuance of SFAS No. 130. However, they were reported not as part of net income but directly in shareholders’ equity. The items made their way into the income statement only if they became realized gains or losses by, for example, selling securities. Notice that the AK Steel disclosures in Exhibit 2.9 list the reclassification of gains on securities that had previously been recognized in other comprehensive income. When these gains were realized they were reported in net income. However, since they had earlier been included in other comprehensive income, avoiding double counting them requires an adjustment to other comprehensive income in the year of sale.
SFAS No. 130 permitted other comprehensive income to be reported in three different ways. The preferred alternative was the income statement format of AK Steel, though reporting other comprehensive income in a separate income statement was also permitted. The third option permitted other comprehensive income to be reported directly in shareholders’ equity. It should come as no surprise that most firms have elected this third option. Firms have an aversion to including items in the income statement that have the potential to increase the volatility of earnings. Hence, given the option, firms can and did choose to avoid the income statement.
There is scant evidence at this time that statement users pay any attention to other comprehensive income. Companies do not include other comprehensive income in discussions of their earnings performance, nor does the financial press comment on it when earnings are announced. Earnings per share statistics do not incorporate other comprehensive income. Other comprehensive income is not currently part of earnings analysis. Hence, we consider it no further. Attitudes may change, however, about the usefulness of other comprehensive income as analysts and others become more familiar with these relatively new disclosures. It seems worthwhile to at least be made aware of these disclosures as part of a thorough treatment of income statement structure and content.
With the structure of the income statement and relevant GAAP now reviewed, the nature of nonrecurring items considered, and methods of locating nonrecurring items outlined and illustrated, we can turn to the task of developing the sustainable earnings series.