Changes in reporting comprehensive income

Transcription

1 No March 2012 Technical Line FASB final guidance Changes in reporting comprehensive income In this issue: Overview... 1 Background... 2 Reporting comprehensive income... 3 Reclassification adjustments... 4 Reporting AOCI... 5 Income taxes... 5 Reporting for an equity method investee... 6 Interim reporting... 7 Guarantor financial statement reporting requirements... 8 Retrospective application in a new registration statement... 8 Effective date and transition... 9 Appendix A: Single continuous statement presentation Appendix B: Two consecutive statement presentation Appendix C: Items required to be reported as OCI What you need to know In annual periods, companies will have to present components of net income and other comprehensive income and a total for comprehensive income in a single continuous statement or two consecutive statements. Companies will no longer be permitted to present components of other comprehensive income solely in the statement of stockholders equity. In interim periods, companies will have to present a total for comprehensive income in a single continuous statement or two consecutive statements. For public companies, the new guidance is effective for fiscal years, and interim periods within those years, beginning after 15 December For calendar year-end public companies, that means the first quarter of For nonpublic companies, the new guidance is effective for fiscal years ending after 15 December 2012 and interim and annual periods thereafter. Overview With Accounting Standards Updates and (the ASUs) and an update to International Accounting Standard 1, 3 the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) achieved convergence on the presentation of other comprehensive income (OCI) and increased its prominence. Differences will continue to exist in the types of items included in OCI under US GAAP and IFRS.

2 The major changes for companies that report under US GAAP are as follows: In annual periods, they will be required to present components of net income and OCI and a total for comprehensive income in either a single continuous statement or two consecutive statements. They will no longer be allowed to present components of OCI solely in the statement of stockholders equity. They will have to present a total for comprehensive income in either a single continuous statement or two consecutive statements in interim periods. Previously, that information was not required to be presented in a statement for interim periods. Instead, companies were permitted to present a total for comprehensive income in the notes to the interim financial statements. They will have to present changes in accumulated other comprehensive income (AOCI) by component (e.g., unrealized gains and losses on available-for-sale securities) in the statement of stockholders equity or in the notes to the financial statements. Companies were previously required to separately present AOCI in the statement of financial position and the accumulated balances for each of its components in the statement of financial position, the statement of changes in equity or a note to the financial statements. The FASB eliminated the most popular method of presenting other comprehensive income. Consistent with existing requirements, the new guidance applies to all companies except not-for-profit companies that follow ASC , Not-for-Profit Entities Presentation of Financial Statements. Reclassification adjustments are necessary to avoid double-counting items in comprehensive income that are presented as a part of net income for a period that had also been presented as part of OCI in that period or earlier periods. ASU initially would have required companies to present reclassification adjustments for each component of net income and OCI on the face of the financial statements. However, the FASB removed that requirement after constituents raised concerns about the cost and difficulty of tracking the information and how it would clutter the financial statements. The FASB has added to its agenda a project to consider whether there should be additional presentation and disclosure requirements for reclassification adjustments. In the meantime, companies continue to be required to present details of amounts reclassified out of AOCI on the face of the financial statements or in the notes to the financial statements. Many companies have historically made these disclosures in the notes to the financial statements. Background The purpose of reporting comprehensive income is to reflect all changes in equity (other than transactions with owners in their capacity as owners) that result from transactions and other economic events. Comprehensive income is defined as the change in equity (net assets) of a business entity during a period from transactions and other events and circumstances from nonowner sources (i.e., net income plus OCI). These changes in equity (net assets) are governed by other standards and may include items such as unrealized gains and losses on available-for-sale securities, foreign currency translation adjustments, the effective portions of gains and losses on derivative 2 8 March 2012 Technical Line Changes in reporting comprehensive income

3 instruments that qualify as cash flow hedges, and amounts associated with defined benefit pension or other postretirement benefits. Neither ASC 220, Comprehensive Income, nor the ASUs address when transactions should be recognized or how they should be measured in the financial statements. The guidance also doesn t outline principles governing whether a component of comprehensive income should be presented as a component of OCI or net income. Instead, individual standards require certain items to be included in OCI. (See Appendix C for a list of items required to be reported in OCI and the standards requiring that treatment.) Reporting comprehensive income Companies previously had three options for presenting a total for comprehensive income and the components of OCI in annual periods: In a single continuous statement that also includes components of net income In a separate statement of comprehensive income In a statement of stockholders equity The ASUs eliminate the option of reporting comprehensive income and the components of OCI solely in the statement of stockholders equity. Instead the ASUs require that a total for comprehensive income and the components of OCI and net income be reported in a single continuous financial statement of comprehensive income or in two separate but consecutive financial statements of net income and comprehensive income. This will be a change for most companies, because historically the most common method of presentation was to display comprehensive income and the components of OCI in the statement of stockholders equity. Appendix A illustrates the single continuous statement approach. Appendix B illustrates the two consecutive statement approach. Illustration 1 displays a statement of stockholders equity without the components of OCI presented. Illustration 1 Statement of stockholders equity Company ABC Statement of Stockholders Equity Year Ended 31 December 2012 Total Retained earnings Accumulated other comprehensive income Common stock Paid-in capital Noncontrolling interest Beginning balance $ 7,704,000 $ 6,700,000 $ 170,000 $ 200,000 $ 600,000 $ 34,000 Net Income 1,508,000 1,206, ,600 Other comprehensive income 48,750 39,000 9,750 Common stock issued 150,000 50, ,000 Dividends declared on common stock (30,000) (30,000) Ending balance $ 9,380,750 7,876,400 $ 209,000 $ 250,000 $ 700,000 $ 345,350 If a company chooses the two consecutive statement approach, the statement of comprehensive income would immediately follow the statement of net income. The statement of comprehensive income would begin with net income 4 and would include all components of OCI and totals for OCI and comprehensive income. 3 8 March 2012 Technical Line Changes in reporting comprehensive income

4 Companies are not required to use the term comprehensive income or other comprehensive income in their financial statements. They may use other terms, such as total non-owner changes in equity. If a company has an outstanding noncontrolling interest in a less than wholly owned subsidiary, the company would have to show amounts for both net income and comprehensive income attributable to the company s shareholders as well as amounts attributable to the noncontrolling interest in a less than wholly owned subsidiary in the financial statement(s) in which net income and comprehensive income are presented. Appendices A and B illustrate the presentation of comprehensive income when noncontrolling interests are present. How we see it It is too early to tell whether companies will gravitate to a single continuous or two consecutive statement approach for presenting OCI. We expect that companies seeking to highlight net income and EPS may lean toward the two consecutive statement approach. Reclassification adjustments As described previously, reclassification adjustments are required to avoid double-counting in comprehensive income components that are included in net income for a period that had also been presented as a part of OCI in that period or earlier periods. For example, realized gains on the sale of available-for-sale securities recognized in net income in a period must be deducted from OCI in that period if they were already included in OCI as unrealized gains or losses. These reclassifications are referred to as reclassification adjustments out of AOCI. Reclassification adjustments out of AOCI may be presented on the face of the financial statement in which the components of OCI are presented using either a gross or net display. When using the net display, the gross amounts are disclosed in the notes to the financial statements. For example, in a gross display the reclassification adjustment for realized gains and losses on the sale of securities would be shown separately from other changes in unrealized holding gains and losses on available-for-sale securities. Alternatively, in a net display, reclassification adjustments would be combined with other changes in the OCI component balance and the gross amounts (e.g., current-period gain/loss and reclassification adjustment) disclosed in the notes to the financial statements. The gross display of reclassification adjustments is shown in Appendices A and B. The following excerpt from those statements illustrates the gross display of reclassification adjustments for unrealized holding gains on available-for-sale securities: Illustration 2 Gross display of reclassification adjustments 2012 Unrealized gains on available-for-sale securities Unrealized holding gains arising during the period $ 450,000 Less: Reclassification adjustments for gains included in net income (125,000) Unrealized gains on available-for-sale securities, net $ 325, March 2012 Technical Line Changes in reporting comprehensive income

5 Unrealized holding gains of $450,000 represent unrealized gains in 2012 before reclassification adjustments. This amount is presented separately from the reclassification adjustments for gains included in net income of $125,000. If a net display were used, only unrealized gains on available-for-sale securities, net of reclassification adjustment of $325,000 would be presented on the face of the financial statements. The gross amounts would be disclosed in the notes to the financial statements. Reporting AOCI AOCI is the cumulative total of OCI that is included as a component of shareholders equity (other than amounts attributable to a noncontrolling interest). Companies were previously required to separately present AOCI in the statement of financial position and the accumulated balances for each of its components (e.g., foreign currency and unrealized gains on securities) in the statement of financial position, the statement of changes in equity or a note to the financial statements. Reclassifications into net income are not required to be presented or disclosed. Under the new guidance, companies must present changes in AOCI by component in the statement of stockholders equity or in the notes to the financial statements. The amounts presented under this requirement will differ from the amounts presented for each component of OCI on the statement where comprehensive income is presented if a company has a noncontrolling interest in a less than wholly owned subsidiary. That s because only the amount attributable to the company s shareholders is presented in AOCI. Companies are not required to present accumulated amounts attributable to a noncontrolling interest in a less than wholly owned subsidiary by component. The following illustration shows the presentation of changes in AOCI (for a single year) in the notes to the financial statements (the net changes in AOCI are presented in the statement of stockholders equity, as shown in Illustration 1). Illustration 3 AOCI disclosure presentation Company ABC Notes to the Financial Statements Year Ended 31 December 2012 Foreign currency Unrealized gains on securities Defined benefit pension plans Accumulated other comprehensive income Beginning balance $ 8,000 $ 219,000 $ (57,000) $ 170,000 Current-period other comprehensive income 52, ,000 (182,000) 39,000 Ending balance $ 60,000 $ 388,000 $ (239,000) $ 209,000 Income taxes The requirements in ASC 220 related to income taxes remain unchanged. A company is required to disclose the income tax effect allocated to each component of OCI, including reclassification adjustments. Each component may be displayed either (1) net of the related income tax effect or (2) before the related income tax effect, with one separate amount shown for the aggregate income tax expense or benefit related to the total of OCI components. Regardless of the method selected, the amount of income tax expense or benefit allocated to each component of OCI, including reclassification adjustments, must be displayed either on the face of the related financial statement or in the notes to the financial statements. 5 8 March 2012 Technical Line Changes in reporting comprehensive income

6 Reporting for an equity method investee A company that accounts for an equity method investment in accordance with ASC , Investments Equity Method and Joint Ventures, continues to be required to record its proportionate share of the components of OCI of an investee with a corresponding adjustment to its investment account. When presenting the proportionate share of an investee s OCI in the statement in which comprehensive income is presented, an investor may combine its proportionate share of OCI from its investees with its own OCI components and present the aggregate of those amounts. Alternatively, an investor is permitted to display components of OCI related to an equity method investee separately from the investor s OCI components. The following illustrates both presentations. Illustration 4 Reporting comprehensive income for an equity method investee The following presentation alternatives are excerpts from the statement in which comprehensive income is reported. Assumptions: An investor owns a 40% investment in another entity (investee) that it accounts for as an equity method investment. The investee has OCI (net of tax) totaling $10,000 solely for the appreciation in value of available-for-sale securities. Therefore, the investor s share is $4,000. The investor has OCI (net of tax) relating to available-for-sale securities of $12,000 and foreign currency translation adjustments of $6,000. There are no reclassification adjustments or noncontrolling interests in a less than wholly owned subsidiary. Alternative 1 Investor s components of OCI are combined with investee s components: Net income $ 50,000 Other comprehensive income, net of tax: Unrealized gain on securities 1 16,000 Foreign currency translation adjustment 6,000 Comprehensive income $ 72,000 Alternative 2 Investee s components of OCI are displayed separately: Net income $ 50,000 Other comprehensive income, net of tax: Unrealized gain on securities 12,000 Foreign currency translation adjustment 6,000 Equity interest in investee s unrealized gains 4,000 Comprehensive income $ 72,000 1 Includes investor s share ($4,000) of the investee s unrealized gains An investor is not required to display its proportionate share of an investee s comprehensive income in the same manner (i.e., in a single continuous statement or two consecutive statements) the investee uses in its financial statements. 6 8 March 2012 Technical Line Changes in reporting comprehensive income

7 Interim reporting Companies were previously required to report a total for comprehensive income in the condensed interim financial statements. Many companies reported that total in the notes to the financial statements. The ASUs, however, will eliminate this option and instead require companies to present a total for comprehensive income in either a single continuous statement or two consecutive statements. The following two illustrations provide examples of the approaches when there is no noncontrolling interest in a wholly owned subsidiary. Illustration 5 Single continuous statement interim presentation ABC Company Condensed Consolidated Statement of Comprehensive Income Quarters Ended 31 March Revenues $ 1,037,500 $ 998,750 Expenses (626,250) (587,500) Gain on sales of securities 168, ,250 Income from operations, before tax 580, ,500 Income tax expense (203,000) (195,125) Net income $ 377,000 $ 362,375 Earnings per share basic and diluted $ 0.16 $ 0.16 Comprehensive income $ 389,188 $ 379,438 Illustration 6 Two consecutive statement interim presentation ABC Company Condensed Consolidated Statement of Net Income Quarters Ended 31 March Revenues $ 1,037,500 $ 998,750 Expenses (626,250) (587,500) Gain on sales of securities 168, ,250 Income from operations, before tax 580, ,500 Income tax expense (203,000) (195,125) Net income $ 377,000 $ 362,375 Earnings per share basic and diluted $ 0.16 $ 0.16 ABC Company Condensed Consolidated Statement of Comprehensive Income Quarters Ended 31 March Comprehensive income $ 389,188 $ 379, March 2012 Technical Line Changes in reporting comprehensive income

8 How we see it Using the two statement approach in interim periods would result in a statement of comprehensive income that would only include one line item for total comprehensive income. To avoid a one line item statement, companies may want to consider the single continuous statement presentation approach for interim periods. We understand that the Securities and Exchange Commission (SEC) staff would not object to companies presenting a single continuous statement in interim periods and two consecutive statements in annual periods. Guarantor financial statement reporting requirements Rule 3-10 of Regulation S-X 5 provides relief from the general requirement of full separate reporting by subsidiary issuers and subsidiary guarantors. If certain conditions are met, modified financial information (i.e., condensed consolidated financial information or disclosure only information) may be presented in the parent company s financial statements. When companies prepare condensed consolidated financial information, Rule 3-10(i) instructs them to follow the general guidance on interim financial statements in Article 10 of Regulation S-X regarding the form and content of the condensed information. The rule states that the financial information should be presented in sufficient detail to allow investors to determine the assets, results of operations and cash flows of the consolidating groups. While Regulation S-X does not address the presentation of comprehensive income, we believe companies should report a total for comprehensive income consistent with the interim reporting requirements discussed previously. Retrospective application in a new registration statement When retrospective application of a new standard is required, companies are usually required to revise historical annual financial statements included or incorporated by reference in new or amended registration statements 6 (except Form S-8) after they file interim financial statements that include material changes resulting from the adoption of new guidance. The staff of the SEC s Division of Corporation Finance has indicated that it would not object if a registrant concludes, and its auditor agrees, that there is no need to retrospectively revise previously issued annual financial statements incorporated by reference into a new or amended registration statement as long as the registration statement includes prominent and transparent disclosure of the information required by the ASUs. Registrants can present this information in a number of ways, including in a table similar to the selected financial data table or as part of that table. 8 8 March 2012 Technical Line Changes in reporting comprehensive income

9 Effective date and transition The new guidance is effective for public companies for fiscal years, and interim periods within those years, beginning after 15 December This means the first quarter of 2012 for calendar year-end public companies. For nonpublic companies, the amendments are effective for fiscal years ending after 15 December 2012 and interim and annual periods thereafter. Retrospective application is required and early adoption is permitted. Next steps Companies should decide on a presentation approach. Prior year information must be recast using the new approach. Companies should closely monitor the FASB s deliberations on the presentation of reclassification adjustments and consider providing timely feedback on any new proposal. Endnotes: 1 Accounting Standard Update (ASU) , Presentation of Comprehensive Income 2 ASU , Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No International Accounting Standard 1, Presentation of Financial Statements 4 ASU indicates that the separate statement of comprehensive income may start with net income. However, a proposed ASU, Technical Corrections, was issued in October 2011 that would require companies to begin the statement with net income. The comment period on this proposal ended 13 December Rule 3-10 of Regulation S-X, Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered 6 New or amended registration statements under the Securities Act of 1933 or the Exchange Act of 1934 Ernst & Young Assurance Tax Transactions Advisory 2012 Ernst & Young LLP. All Rights Reserved. SCORE No. BB2310 About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit This publication has been carefully prepared but it necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decision. 9 8 March 2012 Technical Line Changes in reporting comprehensive income

10 Appendix A: Single continuous statement presentation This appendix illustrates the single continuous statement approach for presenting components of net income and OCI and a total for comprehensive income for annual reporting periods. ABC Company Consolidated Statement of Comprehensive Income Years Ended 31 December Revenues $ 4,150,000 $ 3,995,000 Expenses (2,505,000) (2,350,000) Gain on sales of securities 675, ,000 Income from operations, before tax 2,320,000 2,230,000 Income tax expense (812,000) (780,500) Net income 1,508,000 1,449,500 Less: net income attributable to the noncontrolling interest (301,600) (289,900) Net income attributable to ABC shareholders 1,206,400 1,159,600 Earnings per share basic and diluted $ 0.51 $ 0.49 Other comprehensive income, before tax 1 Foreign currency translation adjustments 2 100, ,000 Unrealized gains on available-for-sale securities 3 Unrealized holding gains arising during period 450, ,000 Less: Reclassification adjustments for gains included in net income (125,000) (100,000) Unrealized gains on available-for-sale securities, net 325, ,000 Defined benefit pension plan 4 Prior service cost arising during period (100,000) (95,000) Net loss arising during period (300,000) (200,000) Less: amortization of prior service cost included in net periodic pension cost 50,000 50,000 Defined benefit pension plan, net (350,000) (245,000) Other comprehensive income, before tax 75, ,000 Income tax expense related to components of other comprehensive income (26,250) (36,750) Other comprehensive income, net of tax 48,750 68,250 Comprehensive income 1,556,750 1,517,750 Less: comprehensive income attributable to noncontrolling interest (311,350) (303,550) Comprehensive income attributable to ABC shareholders $ 1,245,400 $ 1,214,200 1 This illustrates the before tax presentation option. A company may also elect to present amounts net of related tax effects. Under either alternative, the amount of income tax expense or benefit allocated to each component of OCI must be either displayed on the face of the financial statements or disclosed in the notes. 2 It is assumed that there was no sale or complete or substantially complete liquidation of an investment in a foreign entity. Therefore, there is no reclassification adjustment at period end. 3 Reclassification adjustments are reported separately from other changes in the respective balance (gross display). Alternatively, reclassification adjustments may be combined with other changes in the OCI component balance with gross amounts (current-period gain/loss and reclassification adjustment) disclosed in the notes to the financial statements. 4 Reclassification adjustments are reported separately from other changes in the respective balance (gross display). Alternatively, reclassification adjustments may be combined with other changes in the OCI component balance with gross amounts (prior service cost and net loss for the defined benefit pension plans less amortization of prior service cost) disclosed in the notes to the financial statements March 2012 Technical Line Changes in reporting comprehensive income

11 Appendix B: Two consecutive statement presentation This appendix illustrates the two consecutive statement approach for presenting components of net income and OCI and a total for comprehensive income for annual reporting periods. ABC Company Consolidated Statement of Net Income Years Ended 31 December Revenues $ 4,150,000 $ 3,995,000 Expenses (2,505,000) (2,350,000) Gain on sales of securities 675, ,000 Income from operations, before tax 2,320,000 2,230,000 Income tax expense (812,000) (780,500) Net income 1,508,000 1,449,500 Less: net income attributable to the noncontrolling interest (301,600) (289,900) Net income attributable to ABC shareholders $ 1,206,400 $ 1,159,600 Earnings per share basic and diluted $ 0.51 $ 0.49 ABC Company Consolidated Statement of Comprehensive Income Years Ended 31 December Net Income $ 1,508,000 $ 1,449,500 Other comprehensive income before tax 1 Foreign currency translation adjustments 2 100, ,000 Unrealized gains on available-for-sale securities 3 Unrealized holding gains arising during period 450, ,000 Less: Reclassification adjustments for gains included in net income (125,000) (100,000) Unrealized gains on available-for-sale securities, net 325, ,000 Defined benefit pension plan 4 Prior service cost arising during period (100,000) (95,000) Net loss arising during period (300,000) (200,000) Less: amortization of prior service cost included in net periodic pension cost 50,000 50,000 Defined benefit pension plan, net (350,000) (245,000) Other comprehensive income, before tax 75, ,000 Income tax expense related to components of other comprehensive income (26,250) (36,750) Other comprehensive income, net of tax 48,750 68,250 Comprehensive income 1,556,750 1,517,750 Less: comprehensive income attributable to noncontrolling interest (311,350) (303,550) Comprehensive income attributable to ABC shareholders $ 1,245,400 $ 1,214,200 1 This illustrates the before tax presentation option. A company may also elect to present amounts net of related tax effects. Under either alternative, the amount of income tax expense or benefit allocated to each component of OCI must be either displayed on the face of the financial statements or disclosed in the notes. 2 It is assumed that there was no sale or complete or substantially complete liquidation of an investment in a foreign entity. Therefore, there is no reclassification adjustment at period end. 3 Reclassification adjustments are reported separately from other changes in the respective balance (gross display). Alternatively, reclassification adjustments may be combined with other changes in the OCI component balance with gross amounts (current-period gain/loss and reclassification adjustment) disclosed in the notes to the financial statements. 4 Reclassification adjustments are reported separately from other changes in the respective balance (gross display). Alternatively, reclassification adjustments may be combined with other changes in the OCI component balance with gross amounts (prior service cost and net loss for the defined benefit pension plans less amortization of prior service cost) disclosed in the notes to the financial statements March 2012 Technical Line Changes in reporting comprehensive income

12 Appendix C: Items required to be reported as OCI Guidance that requires items to be recorded in OCI includes: ASC , Investments Debt and Equity Securities Unrealized holding gains and losses on available-for-sale securities Unrealized holding gains and losses that result from a debt security being transferred into the available-for-sale category from the held-to-maturity category Amounts recognized in OCI for debt securities classified as available-for-sale and held-to-maturity related to an other-than-temporary impairment recognized in accordance with Section if a portion of the impairment was not recognized in earnings Subsequent decreases (if not an other-than-temporary impairment) or increases in the fair value of available-for-sale securities previously written down as impaired ASC 830, Foreign Currency Matters Foreign currency translation adjustments Foreign exchange gains and losses from intra-entity foreign currency transactions of a long-term investment nature, when the companies to the transaction are consolidated, combined or accounted for by the equity method in the reporting entity s financial statements Gains and losses on foreign currency transactions that are designated as, and are effective as, economic hedges of a net investment in a foreign entity, beginning as of the designation date ASC 715, Compensation Retirement Benefits Gains or losses associated with pension/other postretirement benefits that are not recognized immediately as a component of net periodic benefit cost Prior service costs or credits associated with pension/other postretirement benefits Transition assets or obligations associated with pension/other postretirement benefits that are not recognized immediately as a component of net periodic benefit cost ASC 815, Derivatives and Hedging Gains and losses (effective portion) on derivatives that are designated as and qualify as cash flow hedges 12 8 March 2012 Technical Line Changes in reporting comprehensive income