In this video, we walk through 5 FAR practice questions teaching about the statement of comprehensive income. These questions are from FAR content area 1 on the AICPA CPA exam blueprints: Financial Reporting.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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The Statement of Comprehensive Income
The statement of comprehensive income is a critical financial document that expands upon the traditional net income statement, providing stakeholders with a fuller picture of a company’s financial health. This statement captures all changes in a company’s equity during a particular period that are not due to transactions with shareholders. It thus plays a vital role in financial reporting and is instrumental in aiding investors, analysts, and corporate management in making informed decisions.
Purpose
The primary purpose of the statement of comprehensive income is to provide a complete picture of all changes in equity that affect a company, beyond what is captured by traditional net income. Traditional net income includes revenues and expenses that are realized during the reporting period, which are reflective of the day-to-day operations of a company. However, this measure alone does not capture all financial movements that can influence a company’s equity.
For example, a company may have investments in foreign markets. Fluctuations in exchange rates can lead to gains or losses in the value of these investments, but these are not realized through day-to-day operations. Similarly, a company might have portfolios of securities, and the unrealized gains or losses from these assets due to market fluctuations are not captured in the net income. The statement of comprehensive income includes these items under “other comprehensive income,” ensuring that stakeholders have a broader understanding of financial dynamics that do not directly stem from operational activities.
Objectives
The objectives of the statement of comprehensive income revolve around enhancing transparency and providing a broader understanding of a company’s financial health. It helps in:
- Enhanced Decision Making: By providing a detailed look at both realized and unrealized gains and losses, the statement enables better investment and operational decisions. For instance, recognizing unrealized losses on securities can signal to management and investors alike about potential future impacts on cash flow, influencing strategic decisions.
- Regulatory Compliance and Comparability: With the adoption of comprehensive income reporting, companies adhere to international financial reporting standards, such as IFRS and GAAP. This compliance ensures that financial statements are comparable across different jurisdictions, aiding investors who engage in international investment.
- Risk Assessment: The inclusion of items like foreign currency translation adjustments and unrealized gains or losses on available-for-sale securities provides insight into the risk exposure of a company’s assets. This knowledge is crucial for risk management and financial planning.
Structure
The statement of comprehensive income can be structured in one of two ways:
- Single Statement Approach: This method integrates the income statement with the comprehensive income elements. It starts with net income at the top, followed by items of other comprehensive income, and sums these to arrive at the total comprehensive income.
- Two-Statement Approach: In this approach, the traditional income statement is presented first, concluding with net income. It is immediately followed by a separate statement of comprehensive income, which starts with net income and then lists each item of other comprehensive income, culminating in the total comprehensive income.
For example, consider a company that reports a net income of $100,000. During the year, it also experiences an unrealized gain of $10,000 on foreign currency translation and an unrealized loss of $5,000 on its portfolio of available-for-sale securities. Under the comprehensive income statement, the company would report a total comprehensive income of $105,000 ($100,000 net income + $10,000 unrealized gain – $5,000 unrealized loss).
Example of a Comprehensive Income Statement Calculation
Vista Industrial, which has provided the following financial details for its fiscal year:
- Revenue: $500,000
- Cost of Goods Sold (COGS): $200,000
- Operating Expenses: $100,000
- Interest Expense: $25,000
- Tax Rate: 30%
Step 1: Calculate Net Income
- Operating Income Calculation:
- Gross Profit = Revenue – COGS
- Gross Profit = $500,000 – $200,000 = $300,000
- Operating Income = Gross Profit – Operating Expenses
- Operating Income = $300,000 – $100,000 = $200,000
- Pre-Tax Income Calculation:
- Pre-Tax Income = Operating Income – Interest Expense
- Pre-Tax Income = $200,000 – $25,000 = $175,000
- Net Income Calculation:
- Income Tax = Pre-Tax Income × Tax Rate
- Income Tax = $175,000 × 30% = $52,500
- Net Income = Pre-Tax Income – Income Tax
- Net Income = $175,000 – $52,500 = $122,500
Step 2: Add Other Comprehensive Income (OCI) Items
- Unrealized Gain on Foreign Exchange: +$20,000
- Unrealized Loss on Available-for-Sale Securities: -$15,000
- Gains from Post-Employment Benefit Re-measurement: +$5,000
Step 3: Calculate Total Comprehensive Income
- Total Comprehensive Income = Net Income + OCI Items
- Total Comprehensive Income = $122,500 + ($20,000 – $15,000 + $5,000)
- Total Comprehensive Income = $122,500 + $10,000
- Total Comprehensive Income = $132,500
Conclusion
This comprehensive income of $132,500 provides a more accurate representation of Vista Industrial’s change in equity for the fiscal year than would be apparent from the net income alone. It includes the effects of unrealized gains and losses on foreign currency transactions and marketable securities, as well as adjustments for pension re-measurement. These elements reflect additional economic factors and market conditions impacting the company’s financial position.
In conclusion, the statement of comprehensive income serves as a more holistic tool for understanding all the economic activities that affect a company’s equity beyond the standard net income. By including both realized and unrealized items, this statement provides a clearer, more comprehensive picture of a company’s financial status, crucial for stakeholders involved in decision-making, investment analysis, and regulatory reporting.
