“Comprehensive Income is the change in equity (net assets) of an entity during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. It includes net income and other revenues, expenses, gains, and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Some parts of comprehensive income presently bypass the income statement and are reported in a separate equity section of the balance sheet." Comprehensive income consists of two main categories of net income and other comprehensive income.
"Net income is an enterprise performance measure favored by many financial statement users. However, several income items are not shown on the income statement. Numerous groups of financial statement users have called for revision of the number of income items that bypass the income statement. The accumulated balances of these items are currently reported in permanent equity accounts in the balance sheet, not on the income statement. Although discussed in U.S. accounting literature for over twenty years, the concept of a comprehensive income that captures these income items first became popular outside the United States. The first accounting standard addressing the issue was enacted in Europe. In 1992, the United
Kingdom Accounting Standards Board issued Financial Reporting Standard
3 that introduced a statement of total recognized gains and losses as a Accounting Standards Committee issued an exposure draft of a new income standard and modified it in 1997. It is conceptually similar to recent U.S. comprehensive income efforts."[i]
In December 1980, the Financial Accounting Standards Board formally defined comprehensive income in Concepts Statement No.6, as "the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources.” Description of comprehensive concept in Statement #130 covers wider rage of things than
Statement #6. At the same time, FASB identified in Statement No. 5 that comprehensive income and its components should be reported as part of a full set of financial statements for a period. This project was added to the Board's agenda in September 1995, at the urging of financial statement users. In particular, the Association for Investment Management and
Research wanted FASB to expand the reporting for items of comprehensive income.
In June 1997, Financial Accounting Standards Board issued a new
Statement of Financial Accounting Standards #130 “Reporting Comprehensive
Income.” This act was partially triggered by the AIMR's (Association for
Investment Management and Research) call for more explicit Comprehensive
Income. “The new figure will shine a bright, embarrassing light on items that are now buried in shareholders’ equity, as well as items executives can use to even out bumpy earnings growth,” says Bear Stearns accounting expert Pat McConnell. However even the new statement did not cover what probably it should have covered. The new statement coped only with reporting and presentation of the components of comprehensive income, but it did not explain when they should be recognized and how they should be measured.
Nowadays, the market is very volatile and fair market values of the assets might change instantly. In turn, change in fair market value leads to losses or gains in general value of a company. If these effects find their reflections on the income statement, it will mean very sudden high and low income reported by the company. The reason why FASB adopted the concept of comprehensive income is to give investors a full picture of the financial position of the company. Traditional income statement does not include some of the items, but included in the equity section of the balance sheet. These items are:
. Unrealized gains (losses) on available-for-sale securities
. Change in foreign currency exchange rates
. Adjustments to minimum pension liability
. Hedging gains or losses.
Unrealized gains or losses on available-for-sale securities take place when the fair market value of the securities is different than the one of the balance sheet. To be consistent with accounting regulations, the company has to correct its assets’ value on the balance sheet. These gains or losses do not appear on the income statement because their effect might mislead the investors, in terms of temporary income of the company. On the other hand, the investors should be aware of these gains or losses, and this is the reason for comprehensive income to exist. The owner's equity section of the balance sheet accumulates these changes in the value of the securities.