This week Calcbench decided to take a deeper dive into one of financial reporting’s tricky concepts: Other Comprehensive Income, that item below the income statement that discloses all manner of income that, well, doesn’t have a better home anywhere else. “OCI” is a category of gains and losses exempt from the company’s net income calculation; it could contain amounts from, say, foreign currency fluctuations, or pension plan adjustments, or changes in the value of securities the company has classified as available for sale.
We caught up with one of our customers, Jack Ciesielski of the Analyst’s Accounting Observer, to ask him a few questions about OCI and some of the common challenges in using it properly. Ciesielski has been running the Accounting Observer since 1992, where he offers wide-ranging commentary about financial reporting issues. Ciesielski has also been a member of the Financial Accounting Standards Advisory Council of the Financial Accounting Standards Board, its Investors Technical Advisory Committee, and its Emerging Issues Task Force. He is currently a member of the CFA Institute’s Corporate Disclosure Policy Committee.
CB: We’ve heard Other Comprehensive Income described as ‘the back closet of the income statement’ where everything with no logical home gets buried. Is that a fair description?
JC: It’s pretty fair. Keep in mind, though, that it’s pretty much that way not because companies elect to hide bad news there; it’s a back closet because when hard decisions were being made at the [Financial Accounting Standards Board] about how to account for controversial matters like currency translation adjustments, fair value of marketable securities, benefit plan remeasurements, and derivatives, OCI was used as a tool for compromise.
All those things mentioned had unpleasant earnings volatility associated with their accounting outcomes. Putting them into OCI kept them out of the income statement but not completely invisible. Maybe calling it “the Twilight Zone” of the financial statements would be more descriptive.
CB: Let’s keep the ‘O’ part of the acronym in mind here; it’s only other income. How often do issues in OCI culminate into some material amount of money, really?
JC: It’s not “other” in the sense that companies found quarters in the seat cushions of the executive lounge. It’s “other” only in the sense that the income (or loss) results from completely accounting for all phases of a transaction. For instance, take available-for-sale securities. The balance sheet part of reporting a fair value change in securities holdings gets reported in the balance sheet just fine—but the “other” part affecting earnings doesn’t make it to the income statement. It gets put into OCI.
And yes, it can be material amounts of money. All those things mentioned above that are part and parcel of OCI can be material for a company; it’s just that the OCI holding tank smooths out their recognition in income over time, rather than all at once. Again, go back to the beginning: OCI didn’t formally exist until just before the standard on derivatives reporting, which could not have happened without the creation of OCI.
Accumulated OCI for the SP500 just keeps growing.
CB: Can you give an example of particularly nettlesome disclosures related to OCI? Details that companies get wrong?
JC: OCI itself is a nettlesome concept. I think that it would better handled by revamping the income statement so that all of it is on display in one place, but with more categories to make all operating (and value change) activity more apparent to all readers of financials.
That said, I think a lot of people aren’t aware of how much the strong dollar has affected the currency translation part of OCI and Accumulated OCI—it’s really carved a big chunk out of equity and increased financial leverage. Not sure people are noticing.
CB: Once upon a time, GAAP had a quirk that led banks with deteriorating credit ratings to adjust their net income upward—and thankfully, FASB closed that loop. Do you see other GAAP quirks related to OCI that you’d like to see corrected?
JC: Ugh! That was one ugly quirk. But the gain on deteriorating credit didn’t go through OCI, it was reported in net income. Putting it through OCI was the “fix” and that just happened at the beginning of January, in time for the 4Q reporting season.
As I recall, though, it was the big banks that actually wanted that quirk put in. It made hedging on some of their structured note products more easily attained. It didn’t go according to plan when their credit ratings took that turn downward. Glad that’s closed, but how did it get closed? By putting that result in OCI.
Curing OCI with the FASB’s new financial presentation statement project is the way I’d like to see things corrected.
CB: How about filers’ own use of OCI or Accumulated OCI—what are the practices you see there that might be allowed under GAAP, but nevertheless might be questionable from a good reporting perspective?
JC: The kinds of transactions that wind up reported in OCI are prescribed ones—it’s not like a firm can decide to throw a restructuring charge in there, or some exit costs. It’s not elective that way.
It’s elective, though, in that just about every category of OCI (except for cumulative translation adjustment) contains choices that a firm could make to present everything in the income statement. A firm could elect not to use the Available For Sale category for securities, and just report the fair value changes through earnings. A firm could choose not to use hedge accounting for cash flow hedges, and just report the fair value changes through earnings. A firm could stop deferring gains and losses on remeasurement of benefit plan assets and obligations, and just report the fair value changes through earnings.
Life would be simpler for preparers if they did those things, but earnings would be “untidy.” That’s where preparers and users need to reach agreement: you can do best practice reporting right now (some do), and simplify things, but everyone has to agree to the consequences.
You can find more of Ciesielski’s writing and work at the Analyst’s Accounting Observer.