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Abstract:
The comprehensiveness of income, a key definition in accounting, remains contentions despite decades of debate.
A review of this debate reveals that investors have traditionally argued for more comprehensive definitions of income, whereas managers have traditionally argued for less comprehensive measures. We compare performance for both income definitions and component sets. Our results reveal that among income definitions, comprehensive income defined by Statement 130 dominates both traditional net income and fully comprehensive income. No definition dominates clearly.
This, our findings indicate that different definitions of income are more decision useful in different applications and that comprehensive income component disclosures are useful.
Of the two basic approaches to income measurement, the all-inclusive approach has generally been recognized as more useful to financial statement users than the current operating performance approach. The all-inclusive approach requires that all income items flow through the income statement before being closed to retained earnings. In recent years, however, FASB has promulgated several exceptions to the all-inclusive approach, allowing the income effects of certain transactions to be reported directly in owner's equity.
To bring greater awareness to these bypass items ant to aid financial statement users in assessing a firm's activities and the timing and amounts of a firm's future cash flows, SFAS 130 requires firms to disclose comprehensive income.
Comprehensive income consists of traditional net income and the bypass items, called "other comprehensive income". Although firms are expected to apply accounting principles consistently, a firm is allowed to change an accounting principle when justified by economic conditions. When a change in principle is made, the cumulative effect is disclosed on the income statement for most changes, although it is a paper entry with no impact on cash flows or current operating activities.
Moreover, some accounting changes are reflected on the income statement, while others are reported in the retained earnings statement.
Recognizing the "cumulative effect of accounting changes" as other comprehensive income statement items would both enhance the credibility of net income and provide greater consistency.
Cumulative effect of changes in accounting principle
Companies can change methods of accounting in response to economic or business conditions. The principle under APB Opinion 20, Accounting Changes, requires restating the affected balance sheet account to reflect the balance as if the new...