What Is Other Comprehensive Income?
Net income and other comprehensive income (OCI) are both included in comprehensive income on the Income Statement. However, OCI is made up of revenues, expenses, profits, and losses that are to be included in comprehensive income but not in net income.
In business accounting, other comprehensive income (OCI) includes revenues, expenses, gains, and losses that have yet to be realized. Therefore, they are excluded from net income on an income statement. OCI is the difference between net and comprehensive income. A portfolio of bonds that have not matured and have not been repaid is a common example of OCI. Gains or losses from fluctuating bond values cannot be fully determined until the bonds are sold. As a result, interim adjustments are reported in other comprehensive income.
Other Comprehensive Income – A Closer Look
Corporate earnings can be broken down in a variety of ways. To compensate, the Financial Accounting Standards Board (FASB) compels corporations to utilize universal metrics. This is to provide easily accessible information about a company’s financial status to investors and analysts. According to the FASB’s Statement of Financial Accounting Standards No. 220, a business must report comprehensive income in a single continuous financial statement and disclose its components in two sections: net income and other comprehensive income.
Under the amendments to Topic 220, Comprehensive Income, in this Update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income, and a total for other comprehensive income, along with the total of comprehensive income in that statement. (Source: asc.fasb.org)
GAAP Versus FASB Regarding Other Comprehensive Income
According to current US Generally Accepted Accounting Practices, reporting companies are given three options for showing other comprehensive income (OCI) and its components in financial statements. One of those alternatives is to include the components of OCI in the statement of changes in stockholders’ equity. FASB Update 220 does away with that possibility. Furthermore, the current US GAAP does not necessitate the presenting of the statement of net income and other comprehensive income in the same order.
Further, current U.S. GAAP does not require a business to report reclassification changes from OCI to net income on the face of the financial statements. FASB requires reclassification per Update 220. These modifications affect both annual and interim financial statements. These enhancements will assist financial statement users in better understanding the causes of a change in an entity’s financial condition and results of operations.
Other Comprehensive Income – Why It Matters To Investors
Other comprehensive income is an important financial analysis statistic. It provides for a more comprehensive assessment of a company’s earnings and overall profitability. The income statement remains the major indicator of a company’s profitability. However, OCI improves the financial reporting’s reliability and transparency. Other income data cannot reveal the company’s day-to-day operations. But, it can provide insight into other important items. An analyst can gain insight into the management of the company’s investments. For example, consider the unrealized profits/losses on the reported investments. They give an indication in advance and may foretell the company’s actual, realized gains or losses on its investments.
Furthermore, consider a company with overseas operations. The OCI section can help to understand the dynamics of the company’s global operations. For example, to estimate the impact of currency fluctuations. Finally, it aids in determining how much a company’s future pension commitments may affect unrealized earnings.
OCI is intended to provide the reader of a company’s financial statements with a more detailed understanding of the entity’s financial situation. Unfortunately, in practice, it may add too much complexity to the income statement. The line items provided in the OCI section of the financial statements are unlikely to be understood by a non-accountant. Nevertheless, investors must critically evaluate a company’s financial statements in order to assess its fundamentals, financial stability, and credibility. OCI includes unrealized gains and losses. Understanding this data will help an investor better analyze a company and make sound investment decisions.
Examples of Other Comprehensive Income
OCI includes revenues, expenses, profits, and losses that have not yet been recognized. When an underlying transaction, such as the sale of an investment is completed, only then is something realized. Consider a company that invests in bonds and the value of those bonds changes. The difference is recognized as a gain or loss in the OCI account. The actual gain or loss connected with the bonds is only realized after the company sells them. At that point, they can relocate the gain or loss out of other comprehensive income and onto a line item higher on the income statement, so it is a part of net income.
Other examples of OCI
- Bonds – Any change in the available-for-sale asset’s value may be included in OCI. As long as the bonds are not classified as held-to-maturity by the company.
- Foreign currency transactions – While conducting business activities, a company may decide to hedge against currency changes. The analyst will comprehend the significance of currency rate variations and foreign currency exchange profits or losses incurred by inspecting OCI. This can result in gains or losses if a company’s currency holdings move, which they frequently do. However, only major corporations that deal in multiple currencies need to be concerned about foreign currency-derived comprehensive income.
- Pension plans – Adjustments to a pension plan or post-retirement benefit plan are an important component of OCI. Individuals can investigate the implications of pension plans and company retirement plans. An employer might intend to pay pensions to employees who retire at a later period. If the assets necessary for the plan are insufficient, the firm’s pension plan liability would increase. The organization must make appropriate plans. Conversely, they can generate substantial revenue If the plan’s value rises. Therefore, the difference between the previous and new values can be recognized as comprehensive, minus any pension payouts.
- Gains and losses – While going over the components of OCI an analyst can grasp the unrealized gains and losses on bonds and shares. If a share is bought for $100 and its fair market value is $120, the unrealized gain is $20. By reading about the OCI components, an analyst can determine the fair value of a company’s interests. They might also learn about the firm’s unrealized gains or losses on investments classified as available for sale.
Frequently Asked Questions
What Is the Purpose of OCI?
The goal of OCI is to provide deeper insight for measuring a company’s value. It helps to do this by displaying a larger view of the entire net income. OCI lists a company’s uncompleted or unrealized transactions. As such, it represents the difference between a company’s net income and comprehensive income. Retained earnings do not include OCI. Retained earnings are the funds leftover from corporate profits after all expenses and dividends have been paid.
What Are the Components of Other Comprehensive Income?
OCI consists of revenues, expenses, gains, and losses that a firm recognizes but which are excluded from net income. Investors must examine not only the realized profits and losses indicated on the income statement. But, also the unrealized income and losses listed as OCI.
Where Does OCI Appear on Financial Statements?
Comprehensive income and OCI both appear on the income statement. Accumulated other comprehensive income (AOCI) instead appears on the balance sheet as part of owners’ equity. AOCI refers to extraordinary gains and losses. AOCI will appear as a special item on a company’s balance sheet in the shareholder equity section. The AOCI account is the designated location for unrealized profits or losses on things classified as other comprehensive income.
Up Next: What Is Tax Planning?
Tax planning refers to financial planning aimed at reducing tax liabilities and optimally utilizing tax exemptions, rebates, and tax benefits to the full extent allowed by law. Tax-efficient investing requires the review of one’s financial situation from a tax perspective. The objective is to ensure that all elements work together to pay the least amount of taxes possible. Ultimately, a tax-efficient plan is one that reduces the amount of money a taxpayer owes in taxes. Individual investors should include tax preparation as part of their financial plans. Reducing tax liability and increasing one’s ability to contribute to retirement plans are critical success factors.
Tax planning comprises various considerations. For example, the timing and size of income, purchases, and expenditures. However, proper tax planning diminishes tax liability by arranging financial events according to tax implications. Moreover, conforming these decisions to the provisions under taxation laws minimizes any potential legal complications. One of the biggest benefits of tax planning is that the returns can be directed to investments. This is an extremely productive way to make smart investments while fully utilizing the tax benefits, rebates, and exemptions.
