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An evaluation of SFAS No. 130 comprehensive income disclosures

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Abstract

In this study, we provide evidence on the pricing of other comprehensive income (OCI) that differs from most evidence in prior research. Prior archival research has largely concluded that OCI is not priced by investors. In contrast, we provide evidence in the post-SFAS 130 period that OCI is priced on a dollar-for-dollar basis as is predicted by economic theory for transitory income items. We attribute this finding to our use of post-SFAS 130 as-reported measures of OCI rather than pre-SFAS 130 as-if estimates of OCI measures. Furthermore, we document that two components of OCI, foreign currency translation adjustment and unrealized gains/losses on available-for-sale securities, are priced by investors. In the post-SFAS 130 period, we also find that the type of financial statement in which firms report 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. This could be attributed to investors becoming more familiar in the post-SFAS 130 period with the predominant reporting of OCI and its components in the statement of changes in equity. These findings may be relevant to both the Financial Accounting Standards Board and the International Accounting Standards Board, which jointly are undertaking a new project that, in part, is addressing financial statement presentation of OCI items.

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Notes

  1. Mazza and Porco (2004) find 83 percent of companies drawn from a random sample of firms included in a Russell index report OCI in the statement of changes in equity.

  2. The fourth component, derivative securities adjustment, was added to OCI by SFAS 133 “Accounting for Derivative Instruments and Hedging Activities.” Future accounting standards may add more components to OCI. It is important to note that comprehensive income, as defined by the FASB, is not an “all-inclusive” income measure that satisfies the “clean surplus relation.” Non-owner-related changes in equity not specifically mentioned in SFAS 130 and SFAS 133 need not be reported as a component of OCI.

  3. By comparison, SFAS 133 received 150 comment letters (par 215, SFAS 133).

  4. Early papers advocating a focus on current operating income are Paton (1934) and Littleton (1940) while more recent papers are Black (1993) and Holthausen and Watts (2001).

  5. Some papers advocating comprehensive income reporting before the introduction of SFAS 130 are Robinson (1991); Sutton and Johnson (1993); Johnson, Reither, and Swieringa (1995); Beresford, Johnson, and Reither (1996); and Smith and Reither (1996).

  6. The accounting academic community also reacted positively to both the exposure draft and SFAS 130. A number of the arguments described in this paragraph are articulated in Linsmeier et al. (1997a) and (1997b).

  7. Ohlson uses the term “value irrelevance” to refer to items that have no effect on abnormal earnings and, consequently, no effect on goodwill.

  8. Our study differs from Dhaliwal et al. (1999) as we look at the pricing of OCI and its components rather than pricing of total comprehensive income relative to net income.

  9. Hillegeist and Penalva (1999) hand-collected OCI data for a sample of firms in the pre-SFAS 130 period. They provide some evidence that fully disaggregated comprehensive income “can provide significant incremental value-relevant information beyond that provided by net income alone.” Cahan, Courtenay, Gronewoller, and Upton (2000) investigate the pricing of OCI for a sample of New Zealand firms before and after the requirement to report OCI. Their objective is not to determine if OCI is value relevant, rather they focus on whether OCI components should be separately reported. A recent working paper by Kanagaretnam, Mathieu, and Shehata (2005) contemporaneously finds evidence of the value relevance of reported components of OCI using a sample of Canadian firms that are cross-listed in the United States reporting in the post-SFAS 130 period. Kanagaretnam et al. is similar to this study in their use of post-SFAS 130 reported data. However, our sample is much larger and significant, representing over 50 percent of the total market capitalization, and firms in our sample are not subject to multiple reporting regimes.

  10. Hirst, Hopkins, and Wahlen (2004) find that differences in income measurement affect fundamental judgments of specialist analysts. This suggests that the choice of income number, comprehensive or not, may make a difference in the valuation judgments of investors.

  11. Compustat currently reports a few items related to comprehensive income. “Accumulated Other Comprehensive Income (Loss)” (Item 357) reports the balance sheet item that accumulates current and prior comprehensive income as defined by SFAS 130. This item is available sporadically for data-year 2000 and more completely from 2001 forward. Compustat does not currently report any comprehensive income components reported in the financial statements. However, Compustat reports two balance sheet items, “Retained Earnings—Cumulative Translation Adjustment” (item 230) and “Marketable Securities Adjustment (item 238) that can be used to estimate two components of comprehensive income related to foreign currency translations and unrealized gains and losses on marketable securities, respectively.

  12. In the post-SFAS 130 period, NI it has been corrected for any errors in the Compustat data item discovered during the hand collection of OCI data.

  13. Security returns and the calculations of the three as-if OCI components are based on the same variables in Dhaliwal et al. (1999).

  14. Dhaliwal et al. (1999) estimate first a model with net income as the independent variable and then a model with comprehensive income as the independent variable and compare the two R2 measures with Vuong’s (1989) test. Thus, one model is R it   = α 0  + α 1 *NI it  + ε it and the other is R it  = α 0  + α 1 *(NI + OCI) it  + ε it .

  15. By testing coefficient differences we also can provide evidence of whether the restrictions inherent in Dhaliwal et al.’s model were binding.

  16. Similarly, since NI it is assumed to include core earnings that will persist, β1 should be significantly greater than one.

  17. Based on a search of footnotes in the 10-Ks of our sample firms, the residual value in OTHERit consists primarily of two items: (1) reclassification adjustments and (2) unrealized gains and losses, foreign currency adjustments, and hedges related to discontinued operations.

  18. OTHERit cannot be constructed from available Compustat data in the pre-period and therefore is excluded from the as-if regression.

  19. It appears that differences in pricing are driven by the choice of the functional currency. Thus, Bartov (1997) reports that when the functional currency is the dollar, the translation adjustment is not priced, while when the functional currency is the foreign currency, the translation adjustment is positively priced.

  20. Note that the zero median for as-if OCI is due to rounding—all firms had nonzero as-if OCI although the amounts for some firms were very small.

  21. These percentages are larger than those reported in Table 1 of Dhaliwal et al. (1999). This is expected given that our sample consists of S&P 500 firms which are relatively large firms.

  22. Some interesting correlations among our variables in the pre- and post-SFAS 130 periods are (1) the Pearson correlation between returns and comprehensive income NI130 is much larger in the post- than in the pre-SFAS 130 period (0.116 versus 0.059). This also is true of the Spearman correlations. (2) The correlation between returns and as-if OCI is insignificant in the pre-SFAS 130 period (0.039) and small but significant in the post-SFAS 130 period (0.070). However, the correlation between returns and as-reported OCI is highly significant (although not large in magnitude) in the post-SFAS 130 period (0.099). Evidently, this is another indication that the as-if OCI data contain significant measurement error.

  23. Given the significant correlation between as-if and as-reported OCI, we tested for multicollinearity in regression (1a), using tests described in Belsley, Kuh, and Welsch (1980). The highest condition index was 3.42 indicating no evidence that multicollinearity affected our inferences.

  24. Ahmed and Takeda (1995) consider the impact of asset-liability matching on the pricing of unrealized security gains and losses. However, their proxy variable (interest GAP position) capturing the extent of matching was obtained from bank holding regulatory filings. A similar proxy is not available for our sample firms either from Compustat or 10-K fillings.

  25. We believe this procedure was unsuccessful because of the crudeness of our proxies.

  26. These percentages are similar to those reported by Mazza and Porco (2004). We did not detect any disclosure location changes, i.e. from SCE to IS/CI or vice versa, for any of our sample firms over the six-year post-SFAS 130 period.

  27. The t-statistics for the means in Panel B are generally insignificant, most likely due to the lower sample size for that subsample.

  28. A slightly lower percentage of firms reporting OCI in the SCE report negative NI (12.4 percent as compared with 16.1 percent for IS/CI reporting firms).

  29. Consistent with theoretical expectations, neither the SCE or IS coefficient is significantly different from one (t-statistics of 1.59 and 0.40, respectively).

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Acknowledgements

We are grateful for the comments of an anonymous referee, Stephen Penman (editor), Patrick Hopkins, David Ziebart and workshop participants at the University of Houston and the 2005 Annual Meetings of the American Accounting Association,

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Authors and Affiliations

  1. Von Allmen School of Accountancy, University of Kentucky, 355 I Gatton B&E Building, Lexington, KY, 40506-0034, USA

    Dennis Chambers

  2. Financial Accounting Standards Board, 401 Merritt 7, Norwalk, CT, 06856-5116, USA

    Thomas J. Linsmeier

  3. Stephen M. Ross School of Business, University of Michigan, 701 Tappan St, Ann Arbor, MI, 48109-1234, USA

    Catherine Shakespeare

  4. University of Illinois and ALBA, 209 Wohlers Hall, 1206 South Sixth Street, Champaign, IL, 61820, USA

    Theodore Sougiannis

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  1. Dennis Chambers
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  2. Thomas J. Linsmeier
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  4. Theodore Sougiannis
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Correspondence to Dennis Chambers.

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The views expressed in this article are that of Tom Linsmeier (and his co-authors) and do not present positions of the Financial Accounting Standards Board. Positions of the Financial Accounting Standards Board are arrived at only after extensive due process and deliberations.

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Chambers, D., Linsmeier, T.J., Shakespeare, C. et al. An evaluation of SFAS No. 130 comprehensive income disclosures. Rev Acc Stud 12, 557–593 (2007). https://doi.org/10.1007/s11142-007-9043-2

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