THE GLOBALIZATION IMPACT UPON THE FINANCIAL
PERFORMANCE REPORTING. THE NET INCOME VERSUS THE
COMPREHENSIVE INCOME
Solomon Daniela Cristina
University of Bacau, Faculty of Economic Sciences
Bacău, Roumania
e-mail solomon_daniela@yahoo.com
Dragomirescu Simona Elena
University of Bacau, Faculty of Economic Sciences,
Bacău, Roumania
e-mail symonna21@yahoo.com
Abstract
In order to facilitate the analysis and the information’s increase of comparability offered by
enterprise’s financial statement on all markets by all users of the accountancy information, the
accountancy normalization organisms started a revision, harmonization and homogenization of
financial performance statements project. This effort was materialized in IAS 1 “Financial Statements
Presentation” paper that brings major changes in what the financial performance reporting is
concerned, suggesting a new reporting pattern “The Statement of Comprehensive Income”. The
present paper holds forth to approach precisely these aspects of enterprise’s financial performance
reporting need in the frame of globalization, identifying the main limits/barriers that are placed in
front of IFRS implementation, respective of the new performances reporting pattern in the European
Union’s countries, such as:
- cost benefit rapport respective the equilibrium between costs and advantages represents one of the
restrictions that has to be taken into consideration in presenting relevant and trustworthy information,
IFRS implementation involving high costs, the advantages being difficult to quantify in this phase;
- conservatism: the new pattern of performances reporting based on comprehensive income should
proof that is at least as useful as the traditional one based on net income;
- prediction character supposes the impact’s evaluation of the information provided by comprehensive
income in decision making process, respective their use (of information) by analysts in financial
predictions; recent studies proved the fact that the net result foresees the future cash fluxes better than
the aggregated comprehensive income and its components.
Keywords: performance reporting , comprehensive income, net income, IAS 1
JEL classification: M42, M48
1. INTRODUCTION
In the frame of globalization, world became smaller and smaller, the interdependence
between states and the importance of connections between them increased and extended in a
manner without precedent in history, imposing a global approach in the accountancy domain
also. The main phenomena that govern the present accountancy reform process on world
level are: normalization, harmonization, convergence, conformity and accountancy
internationalization.
The International Accounting Standard Board (IASB), international settlement organism,
initiated together with Financial Accounting Standards Board (FASB) several discussion
projects that regard the realization of the complex convergence process realization. The
publishing of International Accounting Standard 1 (IAS 1) “The presentation of financial
statements” revised in September 2007 marks the finalization of the project’s first phase of
revision and harmonization of financial statements presentation, bringing profound changes
on the financial reporting performance, which is based on comprehensive income. The
second phase that started already on the 16th of October 2008 in the same time with the
publishing of the Discussion Paper (DP) Preliminary Views on Financial Statement
Presentation is to examine and answers to fundamental questions connected to presenting
the information in financial statements.
2. CONCEPTUAL DELIMITATIONS CONCERNING
PERFORMANCE
The performance notion is a complex one, due to different meanings that may have,
according to the level from which is regarded: enterprise, management system, team, person
etc. The performance represents a positive result, in favor of an action, that can be
measured. The result may be looked into under two perspectives:
- Measure of investments’ performances, being identified with net income (profit or
loss according to IASB);
- Measure of enterprise increase value, reflected through comprehensive income.
The general IASB frame does not define the net income (accountancy result), using for this
the term “profit or loss”, being actually a component element of the comprehensive income,
respective “un solde intermediaire” [13, p. 106].
A first definition for the comprehensive income is given by Statement of Financial
Accounting Concepts No. 3 Elements of Financial Statements (SFAC 3) in December 1980,
directive replaced afterwards by SFAC 6 (December 1985). SFAC 6 defines comprehensive
income as “the change in equity (net assets) of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. It includes all
changes in equity except those resulting from investments by owners and distributions to
owners” [15, paragraph 70].
IASB defines the total comprehensive income as the change in equity during a period
resulting from transactions and other events, other than those changes resulting from
transactions with owners in their capacity as owners. Total comprehensive income
comprises all components of ”profit or loss” and of ”other comprehensive income” [17,
paragraph 7].
According to international accountancy referential, comprehensive income, reflects
economic performance, which measures the patrimonial enrichment. The firm’s
comprehensive income is determined as difference between the net assets from the period’s
end and beginning, without the contributions from their share-holders and distributors,
respective as difference between incomes and expenses, defined generically.
According to IASB general frame, “incomes” are economic advantages increases during the
accountancy period under the form of assets’ growth or passives’ diminishing, that have as
result the growth of own capitals under other forms than the growth derived from capital
owners’ contributions” [14, p. 231], comprising not only the registered incomes, but also the
unrealized earnings generated by operations that have as effect assets growth or debts
diminishing, without generating an income – is the case of changes in revaluation surplus,
actuarial gains on defined benefit plans, gains arising from translating the financial
statements of a foreign operation, gains on remeasuring available-for-sale financial assets,
the effective portion of gains on hedging instruments in a cash flow hedge [17, paragraph 7].
According to general IASB frame, “expenses are economic advantages decreasing during
the accountancy period under the form of entries or diminishing of assets’ value, or of debts
increases that have as effect the diminishing of own capitals under other forms than the
distributions in the benefit of capitals’ owners” [14, p. 232], comprising both expenses and
loss generated by operations that have as effect the assets decrease or debts increase.
The passing from net income (accountancy result) to comprehensive income allows on one
side the future performance measurement because it takes into consideration not only the
realized earnings, but the unrealized ones too, susceptible to produce in future, and on the
other hand supposes the passing from evaluation in historic costs to evaluation to the fair
value.
3. CONVERGENCES AND DIVERGENCES IN FINANCIAL
PERFORMANCE REPORTING
From the defining for the first time of the concept comprehensive income (in 1980) and up
to the comprehensive income’s reporting 17 years have passed. The American normalizes’
efforts concerning the financial performance were materialized in June 1997 in Statement
no. 130 “Reporting Comprehensive Income” – FAS 130. The companies placed under the
incidence of FAS 130 may choose among three alternatives forms of reporting the
comprehensive income [16, paragraph 22]:
- Combined statement of income and comprehensive income);
- Separate Statement of comprehensive income; și
- Included in statements of changes of stockholders’ equity).
After the adoption of FAS 130 the first studies appeared, studies that showed the
companies’ preference for one of the three alternative reporting forms. Representative for
this aspect is the presentation of a study realized in the United States in 2003. From the 615
companies listed on stock exchange that made the object of the study, 84% from the
American companies and respective 72% from the Japanese ones registered at the Securities
and Exchange Commission of the United States preferred to present the comprehensive
income in a statement of of stockholders’ equity (see table 1).
Table 1 Reporting Format of Comprehensive income
Companies US (2003)
Companies Japan (2003)
Number of
Reporting
companies
Comprehensive income
Number of
Percent Number of
Percent
In statements of changes of
488
84%
25
72%
513
stockholders’ equity
Separate Statement of
69
12%
8
23%
77
comprehensive income
Combined statement of
income and comprehensive
23
4%
2
6%
25
income
Total Companies
580
100%
35
100%
615
Source: AICPA Accounting Trends & Techniques - Annual Reports of US registrant of Japanese
companies, www.fasb.org/project/Hiroshi_Yamada.ppt: [10]
3.1 Reporting the financial performance on international level
Applicable to all entities placed under the influence of International Financial Reporting
Standards (IFRS), IAS 1 revised in 2007 was validated for annual periods that start from or
after the first of January 2009 and brings profound changes on the situations concerning the
financial performance reporting, materialized in changes in both presentation of changes in
equity and presentation of comprehensive income, IAS 1 being in concordance with FASB
requires presented by SFAS 130 Reporting Comprehensive Income.
The standard allows two alternative forms of reporting global performance [17, paragraph
81]:
(a) in the statement of comprehensive income, where both profit and loss and
comprehensive income’s elements are found, or
(b) under two situations: - separate income statement
- comprehensive income statement that starts with profit and loss
and continues with presentation of other elements of comprehensive income – OCI.
Boards IASB, FASB, after the preliminary discussions, suggested that all components
elements of comprehensive income should be presented in just one situation of
comprehensive income [4, p.60], therefore, will improve both the compatibility of the
information presented in financial situations and the users’ ability of comprehension and use
of information in their analyses, because ”they will need to look to only one financial
statement for information on all non-owner changes in an entity’s net asset” [14, p.61].
On international level, the appearance of IAS 1 revised in 2007 established an unique frame,
coherent and homogenous that offers for its users complete information regarding
performance, financial position and cash flow for an entity, influencing the enterprises’
organizational dynamics, through elimination of redundancy, alternatives and conflicts from
the Standards solving therefore several aspects concerning accountancy convergence.
3.2 Reporting the financial performance in Romania
The 1st of January 2005 represents the beginning of IFRS application in European Union.
Taking into consideration the necessity of assuring the conformity to national settlements in
the accountancy domain with the European Union’s settlements, in the financial exercise of
2007, in Romania is continued the gradual implementation of International Financial
Reporting Standards IFRS [19, art.1]. Starting with the 1st of January 2009 public interest
entities placed under the incidence of IFRS will report the financial performance according
to IAS 1 settlements, revised in 2007 and published in December 2008 in European Unions’
Official Journal.
In relation with state’s institutions, all entities, including those applying International
Financial Reporting Standards prepare annual financial statements according to the IV-th
Directive of European Economic Community, approved by the Public Finances Ministry’s
Order nr. 1752/2005 and 2374 from 2007 with subsequent changes and completions, being a
pattern imposed by law. For performance reflecting, societies should prepare an ”income
statements” (”profit and loss account”), written as list, based on incomes and expenses
classification according to their nature, these being presented as three types of activities: of
exploitation, financial and extraordinary, the net income being determined as pertinent
indicator in reflecting the enterprises’ financial performance [18, art.37].
4. NET INCOME OR COMPREHENSIVE INCOME?
The fundamental changes announced in financial reporting started numerous controversies
that can be synthesized in the following three directions:
(A) Net income has higher value relevance than comprehensive income
(B) Comprehensive income has higher value relevance than net income
(C) Comprehensive income and net income have the same value relevance
A. Net income has higher value relevance than comprehensive income
Net income and its subtotals such as operating income have been shown to have predictive
value by numerous studies.
Cheng, Cheung, and Gopalakrishnan (1993) (US): the study takes under consideration the
analysis of three measures concerning the result: operating income, net income, and
comprehensive income. The research results proved two alternative scripts: (a) net income
and/or operating income are superior to comprehensive income as a measure of
performance, or (b) that investors are "fixated" on net income, thus ignoring comprehensive
income.
Dhaliwal, D., K. Subramanyam, and R. Trezevant (1999) they find ”no evidence that
comprehensive income is more strongly associated with returns/market value or better
predicts future cash flows/income than net income. … Our results do not support the claim
that comprehensive income is a better measure of firm performance than net income” [3].
Takashi Yaekura (2005): ”Comprehensive income, by definition, is inferior to net income
as it includes non-recurring (potentially large) changes of fair value that are not relevant to
the ability to generate net cash flows. Comprehensive income serves nobody.
Comprehensive income cannot provide feedback value as the reported figure does not
belong to the (parent company) shareholders. ”Comprehensive income, as performance
measure, is meaningless and harmful to investors” [9]. As argument for sustaining its
affirmations, he makes reference to the words of well-known economist Sir John R. Hicks
(1973), laureate of Nobel Price, that, through his theory does not recommend the use of
comprehensive income:
”Property values, for instance, do not obey the laws of arithmetic; the value of one
piece of property A plus the value of another B, when A and B are sold separately, are not
necessarily equal to the value of A+B when they are sold together” [9].
Wang Yue (2006) - shows that in the majority of the investigated European countries
comprehensive income is value relevant, but less than reported net income [11].
Jurgen Ernstberger (Germany, 2008) – the research result proves the fact that
”comprehensive income appears to provide no incremental value relevant information
beyond net income in explaining stock returns; ”... concerning the components of other
comprehensive income, only unrealized gains and losses from available-for-sale financial
assets in the IFRS sample are clearly incremental value relevant” [5].
Igor Goncharov, Allan Hodgson (2008, Amsterdam) proves the fact that ”net income
dominates aggregated comprehensive income as a shareholder valuation metric and in
predicting cash flows” [7].
It is interesting to present the results of a study realized in Europe that had as purpose the
identification of main indicators of performance including the financial predictions
“Financial Highlights”. Financial institutions and insurance companies have been excluded,
analyzing the research results, we may conclude the fact that sales are in the top of
management preferences (for all the companies taken under study) and net income (86%
among the companies) as indicators with the highest impact and informational value
concerning the performance reporting, comprehensive result not playing a significant role in
financial predictions (see table 2).
Table 2 Performance reporting in Europe
Number of companies
Performance indicators
(in percents)
Sales
100%
Net income
86%
EBIT (Or Net Operating Income)
40%
EBITDA (Gross Operating Income), Or “Adjusted
40%
EBITDA”
Operating margin
30%
EPS (Earnings Per Share)
60%
Source: European Financial Reportimg Advisory Group (EFRAG), Pro-Active Accounting Activities
in Europe (PAAinE), Performance Reporting: A European Discussion Paper, March, 2009,
www.efrag.org: [6, p. 61]
B. Comprehensive income has higher value relevance than net income
Hirst and Hopkins 1998 - ”comprehensive income is useful for analysts only when it is
reported as a separate statement but not useful when it is reported as part of the statement of
changes in stockholders’ equity” [8].
Biddle and Choi (2006) also show that comprehensive income was incrementally value
relevant even before the adoption of SFAS No. 130; they find that comprehensive income
dominates other measures of income in explaining equity returns.
Dennis Chambers, Thomas J Linsmeier, Catherine Shakespeare and Theodore Sougiannis,
(2007) they also find that the type of financial statement in which firms report other
comprehensive income (OCI) and its components affects pricing, consistent with the
conclusions of prior experimental research. However, our evidence suggests that investors
pay greater attention to OCI information reported in the statement of changes in equity,
rather than in a statement of financial performance [1].
Jong-Hag Choi, Somnath Das, Yoonseok Zang (2007), - ‘other comprehensive income’
reported under SFAS No.130 is ”incrementally useful in predicting one-year ahead net
income” [2].
Ristea M. (2004) considers net income as “… an obsolete concept in financial performance
evaluation because … it does not take into consideration the latent earnings and loss
registered directly in own capitals” [14, p. 270] and the comprehensive income “extensive
measure of enterprise performance” [14, p. 274], agreeing with the presentation of a single
situation of comprehensive result concerning the financial reporting, for this stating that
“The elimination from situation concerning the performance reflecting for several elements,
as well as the changes on net active, others than those concerning transactions with owners
is a defiance addressed to financial information” [14, p. 270].
C. Comprehensive income and net income have the same value relevance
Zimmermann and Volmer (2005) comprehensive income and net income have the same
value relevance and O’Hanlon and Pope (1999) UK) report ” no incremental information
content for comprehensive income components” [6, p.24 ].
Keiichi Kubota, Kazuyuki Suda, Hitoshi Takehara (2009) ”net income is one of the most
dominant income measures, and the incremental information content test shows other
comprehensive income items have significant information content… other comprehensive
income is useful information, while we cannot rank between comprehensive income and net
income” [12].
Despite the contradictory opinions, both net and comprehensive incomes are relevant
indicators in appreciation the enterprise performance offering users’ pertinent accountancy
information. (see figure 1)
Source: Hiroshi Yamada, Performance Reporting (FASB/IASB): [10, p.23]
Figure 1 Accounting information and valuation
The importance of net income is given by the following reasons:
- the net result is a result of investments, representing the result of production factors
use;
- the net result has a predictive value, because on its basis are screened the future
cash-flows offering useful information for management;
- represents the basis for dividends distribution being one of the most important
indicators for enterprise share-holders.
The net result needs to be continuously improved an needs altogether ”recycling”, meaning
the “reclassification” in profit or loss during the current period of some amounts that were
recognized in the frame of other elements of comprehensive income in current or anterior
period [17, p. 6]. Without ”recycling” the mother society share-holders will never be able to
evaluate the firms’ performance.
The importance of comprehensive income is given by the following aspects:
- the comprehensive income reflects the change of net assets being determined, on the
basis of information presented in accountancy balance-sheet, as difference between
the net assets from the end and beginning of period, without the contributions from
their share-holders and distributions against them;
- the comprehensive income reflects the growth of enterprise value, representing the
result of owning production factors.
It does not exist a single measure for appreciating the enterprise performance, both the
comprehensive and net incomes prove their utility.
5. CONCLUSIONS
In the process of IFRS implementation a series of barriers/limits can be identified:
- cost benefit report respective the balance between advantages and costs represents one of
the restrictions that should be taken under consideration in presenting relevant and
trustworthy information, the IFRS implementation involving high costs in staff training but
also costs for company’s management for attracting specialized persons in IFRS standards
implementation, the results being difficult to quantify in this phase; “The adoption and
implementation of IFRS standards represent a long and expensive process for companies,
some banks spending several million Euros” shows Sleigh-Johnson, director of Financial
Reporting Division from the Great Britain Accountants Experts Corp quoted by Financial
Paper from the 23rd of March 2009. The process of IFRS implementation continues, 75%
from the EU companies adopting already the IFRS standards [20].
- conservatorism: the new pattern of financial reporting based on comprehensive income
should prove it is at least useful as the traditional one based on net income; “investors are
"fixated" on net income, thus ignoring comprehensive income”;
- the specific character of each country makes the standards implementation a bit difficult to
realize; Romania, as the majority of countries from Europe, is based on a great extent on
debts owners than on the capitals owners as against the Anglo-Saxon countries that are more
based on capital gaining;
- the insufficient development of financial analysts class, these being less active in Europe in
results dissemination – recent studies showed that only 4% of firms benefit from
professional judgment of financial analysts in determination of specific adjustments of
comprehensive income [7, p. 23].
- predictive character supposes the impact evaluation of information given by
comprehensive income in decision making process, respective their use (of information) by
analysts in financial predictions; recent studies proved the fact that net income predicts the
future cash flows better than the aggregated comprehensive income and its components. The
cash-flows prediction offers a sturdiness test, offering fundamental information concerning
the firm’s solvency future. Under present crisis and uncertainty conditions, a corresponding
evaluation to the “right value” is more difficult to realize, the prices being difficult to
evaluate, in comprehensive result asymmetric information being found (the consequence of
accountancy adjustments).
The future of direction in financial reporting is represented by a mixed pattern that makes
possible the cumulative fulfillment of the two requires: result as measure of performance
and result as measure of enterprise value creation.
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