Abstract
Under Accounting Standards Update 2011-05, firms can present comprehensive income (CI), defined as the sum of net income (NI) and other comprehensive income (OCI), in a single continuous statement or two separate, consecutive statements. We identify whether firms use the one- or two-statement approach for the years 2012–2015 and assess the value relevance of CI, NI, and OCI under the alternative approaches. We find that NI is less value relevant under the one-statement approach relative to the two-statement approach, while the value relevance OCI is marginally enhanced. We also find that the decrease (increase) in value relevance of NI (OCI) under the one-statement approach is driven by a decrease (an increase) in the value relevance of operating income (unrealized gains/losses on securitized assets). Additional analyses demonstrate that the reduced value relevance of NI under the one-statement approach persists only in subsamples that report positive OCI. Our findings suggest that, consistent with arguments put forth in comment letters in support of the one-statement approach, increasing the prominence of OCI may result in investors incorporating this information to a greater extent in their valuation decisions. However, consistent with comment letters in opposition to the one-statement approach, we also present evidence that suggests presenting OCI in the same statement as NI may also draw attention away from the portion of NI that reflects the core operations of the firm.
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Notes
Throughout the paper, we refer to these two alternative presentation formats as the one- and two-statement approaches.
Rees and Shane (2012) summarize the potential characteristics that the FASB could use to differentiate between OCI and NI, including the degree of persistence, whether the item is related to core business operations, the degree of management control over an item, and whether the item involves re-measurement.
ASU 2011-05 is effective for fiscal years beginning after December 15, 2011.
In additional analyses (Sect. 6), we explore the extent to which the choice of reporting format indicates opportunistic or appropriate behavior.
For example, comment letter No. 24 from Allergen Inc. states “Presenting net income as a subtotal in the middle of a continuous statement of comprehensive income diminishes the importance of what is the ‘bottom line’ since it draws the attention of the financial statement users away from net income, which we believe is the most important primary financial measure used by management, investors and analysts to determine current company operating performance [emphasis added].” (Wang et al. 2010).
This research design also provides more persuasive evidence that the differential market associations we document for NI and OCI are due to reporting format choice and not differences in the components of NI and OCI across the two reporting formats.
While all the second-stage regressions include firm fixed effects, we utilize a DID methodology as an alternative test of our hypotheses using more restrictive method of controlling for time invariant firm characteristics.
Lin et al. (2018) reports that the vast majority (81%) of their sample firms reported OCI in the statement of stockholders’ equity (i.e., the option that is no longer permitted following ASU 2011-05). Of the firms that reported OCI in the comprehensive income statement, 88% chose the two-statement approach, while 12% chose the one-statement approach.
Prior research has also considered the value relevance of the disaggregated components of OCI, with mixed results. For example, Dhaliwal et al. (1999) find that unrealized gains/losses on marketable securities is the only component of OCI that improves the association between income and returns. Chambers et al. (2007) find that both foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities are value relevant. Mitra and Hossain (2009) use a sample of 697 Standard and Poor firms to investigate the value-relevance of pension transition adjustments and OCI components following the adoption of SFAS 158. They find that the market negatively evaluates information about pension transition adjustments and also provide evidence that the market prices foreign currency adjustments and pension liability adjustments.
Prior literature has also examined whether alternative reporting frameworks can impact information processing costs and investors’ valuation decisions. For example, using a sample of listed firms in South Africa, Lee and Yeo (2016) find a positive association between firm valuation and Integrated Reporting, which they argue reduces information processing costs, particularly in organizationally complex firms.
Chambers et al. (2007) express two econometrics concerns in the estimation: biased coefficient due to panel data and potential serial correlation in the pooled regression. Chambers et al. (2007) mean-difference the independent variables within years and use clustered standard errors to address the biased coefficient and serial correlation issues, respectively. We follow Chambers et al. (2007) and utilize mean-differenced independent variables and clustered standard errors throughout our analyses. We also include firm-fixed effects in all our second-stage models (Eqs. (2)-(4)) and winsorize all continuous variables at the 1% level.
Chambers et al. (2007) and Lin et al. (2018) also include an indicator variable equal to one when net income is negative and interact this variable with NI. However, these studies focus on the value relevance of OCI and do not assess whether the value relevance of NI is different under alternative presentation formats. In order to assess the overall difference in the value relevance of NI under the alternative presentation formats, we estimate Eq. (3) without a comparable indicator variable. In our subsample analyses (Sect. 5), we separately assess differences in the value relevance of NI under the alternative presentation formats for subsamples with positive and negative NI.
ASU 2011-05 states “For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.”.
Rees and Shane (2012) argue that the characteristics of OCI are different across different industries. In addition, the market valuation of OCI components is likely to be different in the financial industry because of its broad exposure to financial instruments, many of which are reported at fair value. Since ASU 2011-05 is applicable to all firms (i.e., not just financial firms which represent a small percentage of overall firms) we choose to focus on firms outside the financial industry in order to provide a general examination of the valuation effects of the presentation formats allowed under ASU 2011-05.
The coefficient estimate for NI reported in Table 5 (0.236) is lower than the coefficient estimate for OCI (1.562). This difference is attributable to decreased value relevance of NI when NI is negative. In our subsample analyses (Sect. 6), we separately assess differences in the value relevance of NI under the alternative presentation formats for subsamples with positive and negative NI.
Lin et al. (2018) also find that certain components of OCI exhibit a negative association with market value.
In order to further support the use of our control sample, Appendix B contains an evaluation of the equal trend assumption for our difference-in-difference model. Specifically, using an OLS framework, we test whether TREAT firms and control firms exhibited different trends in returns and net income (i.e., the two components of value relevance) in the pre-switch period. We find no significant differences in the levels or trend of returns (Table 8) or net income (Table 9) between the two samples in the period prior to the reporting switch, supporting the use of the control sample in the analyses.
This is consistent with the coefficient estimates for NI in Table 6 Panel A.
This also likely why the coefficient estimate for OTHER*POST*TREAT is large (316.799).
We thank an anonymous reviewer for suggesting the additional analyses.
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Appendices
Appendix A: Variable definition
R | Buy and hold raw return for the window from 4 months after prior fiscal year end to 4 months after current fiscal year-end |
CI | Total comprehensive income (Compustat item CI) scaled by market value as of the beginning of the return estimation period |
NI | Net income (Compustat item NI) scaled by market value as of the beginning of the return estimation period |
OCI | Other comprehensive income (Compustat items CI – NI) scaled by market value as of the beginning of the return estimation period |
SIZE | The log of the market value of the firm’s common shares outstanding at fiscal year-end (Compustat items PRCC_F*CSHO) |
LEV | Long-term debt scaled by total assets (Compustat items DLTT/AT) |
ROA | Net income before extraordinary items, scaled by total assets (Compustat items IB/AT) |
OCI_VOL | The standard deviation of other comprehensive income over previous 4 years scaled by total assets from the current period |
NI_VOL | The standard deviation of net income over previous 4 years scaled by total assets from the current period |
COMPLEXITY | The number of non-zero items reported in other comprehensive income (Compustat items AOCIDERGL, AOCIPEN, AOCISECGL, and AOCIOTHER) |
ABS_DER | The absolute value of changes in accumulated other comprehensive income attributable to unrealized gains/losses on derivatives scaled by total assets (Compustat item AOCIDERGL) |
ABS_PEN | The absolute value of changes in accumulated other comprehensive income attributable to unrealized gains/losses on pensions scaled by total assets (Compustat item AOCIPEN) |
ABS_SEC | The absolute value of changes in accumulated other comprehensive income attributable to after-tax changes in fair value, or unrealized gain/loss, on retained interests in securitized assets classified as available-for-sale scaled by total assets (Compustat item AOCISECGL) |
ABS_OTHER | The absolute value of changes in accumulated other comprehensive income attributable to other adjustments scaled by total assets (Compustat item AOCIOTHER) |
DOCI | An indicator variable equal 1 when OCI is negative, and 0 otherwise |
DNI | An indicator variable equal 1 when NI is negative, and 0 otherwise |
ST | An indicator variable equal 1 when OCI is reported in one-statement approach, and 0 when OCI is reported in two-statement approach |
TREAT | An indicator variable equal 1 if the firm switched the presentation from one-statement to two-statement, and 0 otherwise |
POST | An indicator variable equal to 1 for fiscal years after the firm switched from one-statement to two-statement approach, and 0 otherwise |
OPI | Operating income after depreciation (Compustat item OIADP) scaled by market value as of the beginning of the return estimation period |
NOPI | Non-operating income (expense) (Compustat item NOPI) scaled by market value as of the beginning of the return estimation period |
DO | Income from discontinued operations (Compustat item DO) scaled by market value as of the beginning of the return estimation period |
SPI | Special items included in income (Compustat item SPI) scaled by market value as of the beginning of the return estimation period |
DER | Changes in accumulated other comprehensive income attributable to unrealized gains/losses on derivatives scaled by market value as of the beginning of the return estimation period (Compustat item AOCIDERGL) |
PEN | Changes in accumulated other comprehensive income attributable to unrealized gains/losses on pensions scaled by market value as of the beginning of the return estimation period (Compustat item AOCIPEN) |
SEC | Changes in accumulated other comprehensive income attributable to after-tax changes in fair value, or unrealized gain/loss, on retained interests in securitized assets classified as available-for-sale scaled by market value as of the beginning of the return estimation period (Compustat item AOCISECGL) |
OTHER | Changes in accumulated other comprehensive income attributable to other adjustments scaled by market value as of the beginning of the return estimation period (Compustat item AOCIOTHER) |
Appendix B: Equal trend assumption
See Appendix Tables
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Huang, L., Cussatt, M. & Wong-On-Wing, B. The value relevance of comprehensive income under alternative presentation formats permitted by ASU 2011-05. Rev Quant Finan Acc 57, 1123–1153 (2021). https://doi.org/10.1007/s11156-021-00972-7
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DOI: https://doi.org/10.1007/s11156-021-00972-7