A company's statement of profit and loss, also known as its income statement, has its drawbacks. For the most part, the statement accurately reflects a company's past profitability, and earnings growth is one of the primary determinants of a firm's share price performance, but it remains a subjective measure that is open to manipulation. In particular, companies have a fair amount of latitude on the timing and impact of quarterly and annual charges and other expenses.

How a firm generates revenues and turns them into earnings is an important factor, but there are other important considerations. The Financial Accounting Standards Board (FASB) has continued to emphasize a financial measure called other comprehensive income (OCI) as a valuable financial analysis tool. The FASB's stated goal, in general, is to issue guidance "to improve the comparability, consistency and transparency of financial reporting." To accomplish this, it has sought to "increase the prominence of items reported in other comprehensive income."

The Basics of OIC
Back in June 1997, the FASB issued FAS130 on how to report comprehensive income. Other comprehensive income can be seen as a more expansive view of net income. In the past, changes to a company's profits that were deemed to be outside of its core operations or overly volatile were allowed to flow through to shareholders' equity. OCI provides important details on these figures. An important distinction needs to be made between comprehensive and OCI. Comprehensive income is simply the combination of standard net income and OCI. As such, it is literally a more comprehensive and holistic view of the drivers of a company's operations and other activities that are an integral component of its economics.

The FASB's technical definition of comprehensive income is "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 during a period except those resulting from investments by owners and distributions to owners."

OCI can be found as a line item on a company's balance sheet. It is specifically located under the equity section of the balance sheet, as well as under a related statement called the consolidated statement of equity. In more recent years, in addition to the standard balance sheet reporting conventions for OCI, companies have a couple of other ways to present it in their financial statements. They can either list the individual line item components along with the income statement (such as at the bottom of the income statement) or present OCI on its own separate page. This is also part of a long-term goal to help U.S. Generally Accepted Accounting Principles (GAAP) merge more closely with International Financial Reporting Standards (IFRS) as administered by the International Accounting Standards Board (IASB).

To better illustrate the specific components of OCI, here is an example: MetLife. In 2012, one of its recent 10-K filings with the Securities And Exchange Commission (SEC) details standard net income of $6.7 billion, as well as accumulated other comprehensive income of $5.9 billion, $4.9 billion of which stemmed from its current fiscal year. That is a pretty significant driver of its overall profit levels for the year. For the full year, the items that ran through comprehensive income included unrealized gains from derivatives instruments of $1 billion, unrealized investment gains of $4.5 billion, foreign currency translation adjustments of negative $100 million and defined benefit plan adjustments of negative $500 million.

Why OCI Is Important
Understanding the drivers of a company's daily operations is going to be the most important consideration for a financial analyst, but looking at OCI can uncover other potentially major items. For instance, the items listed in the MetLife example above are important and are generally for financial firms. Insurance companies, banks and other financial institutions have large investment portfolios that they manage. Realized gains and losses are going to run through reported net income for the most part, but looking at the unrealized side of the equation can demonstrate how it is managing its investments and if there is the potential for big losses down the road. In this respect, OCI can help an analyst get to a more accurate measure of the fair value of a company's investments.

Looking at OCI can also lend insight into firms that operate overseas and either do currency hedging or have sizable overseas revenues. MetLife's foreign currency adjustment wasn't overly large, but it can help an analyst determine the impact of currency fluctuations on a company's operations. For a U.S.-based firm, a stronger domestic dollar will lower the reported value of overseas sales and profits. Looking at results from a currency-neutral standpoint can help in understanding the actual dynamics of growth and profitability.

Another major category in OCI is the impact on corporate retirement plans. Years of negligible stock returns have placed the pension assets of a number of large corporations below the obligations they must cover for current and future retirees. Examples of these differences can demonstrate just how big the impact can be on a firm. In 2011, Goodyear reported standard net income of $343 million, but a loss of $378 million when subtracting retirement plan expenses. In another report that year, industrial giant General Electric logged regular earnings of $14.2 billion, but had those more than cut in half when factoring in losses on its retirement plans. The extent of future retirement liabilities is certainly an important consideration in estimating a firm's future profit prospects.

The OCI measure was also quite helpful during the financial crisis of 2007 to 2009 and through its recovery. For instance, coming out of the Great Recession, banking giant Bank of America reported a $1.4 billion profit on its standard income statement, but a loss of $3.9 billion based on comprehensive income. The difference had to do with OCI and the unrealized losses that took place in its investment portfolio. Overall, it called into question the quality of the profit figures it held out as its real measure of capital generation for the year.

The Bottom Line
Understanding and analyzing OCI greatly improves financial analysis, especially for financial companies. In an ideal world, there would only be comprehensive income as it includes standard net income and OCI, but the reality is that an astute analyst can combine both statements in his or her own financial models.

Existing disclosures to either detail comprehensive income and all of its components at the bottom of the income statement, or on the following page in a separate schedule, have made analysis easier. A number of accountants have questioned why OCI was listed as part of equity on the balance sheet, but if you look carefully there are a number of places to locate it and help determine the health and total economics of the underlying company.

Related Articles
  1. Term

    What are Non-GAAP Earnings?

    Non-GAAP earnings are a company’s earnings that are not reported according to Generally Accepted Accounting Principles.
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  3. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  4. Stock Analysis

    Fortinet: A Great Play on Cybersecurity

    Discover how a healthy product mix, large-business deal growth and the boom of the cybersecurity industry are all driving Fortinet profits.
  5. Stock Analysis

    2 Catalysts Driving Intrexon to All-Time Highs

    Examine some of the main reasons for Intrexon stock tripling in price between 2014 and 2015, and consider the company's future prospects.
  6. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  7. Technical Indicators

    4 Ways to Find a Penny Stock Worth Millions

    Thinking of trading in risky penny stocks? Use this checklist to find bargains, not scams.
  8. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  9. Investing Basics

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  10. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
RELATED TERMS
  1. Operating Cost

    Expenses associated with the maintenance and administration of ...
  2. Trade Credit

    An agreement where a customer can purchase goods on account (without ...
  3. Normal Profit

    An economic condition occurring when the difference between a ...
  4. Cost Accounting

    A type of accounting process that aims to capture a company's ...
  5. Gross Profit

    A company's total revenue (equivalent to total sales) minus the ...
  6. Receivables Turnover Ratio

    An accounting measure used to quantify a firm's effectiveness ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What are some examples of general and administrative expenses?

    In accounting, general and administrative expenses represent the necessary costs to maintain a company's daily operations ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. How do dividend distributions affect additional paid in capital?

    Whether a dividend distribution has any effect on additional paid-in capital depends solely on what type of dividend is issued: ... Read Full Answer >>
  5. Why can additional paid in capital never have a negative balance?

    The additional paid-in capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!