In June the Financial Accounting Standards Board issued an exposure draft - "Reporting Comprehensive Income" - that would require business enterprises to report another sort of income number.
This disclosure would appear either in a new financial statement or as part of the income statement. The proposal also calls for the reporting the figure on a per-share basis.
"Comprehensive income" incorporates the three "dangling" items now held in suspense in the stockholders' equity section of the balance sheet. The three items are: foreign currency translation adjustments, adjustments for the minimum pension liability, and the unrealized holding gains or losses on available-for-sale securities.
These three items are not currently reported in the income statement. Rather, their financial effects are deferred by placing them immediately into stockholders' equity.
The FASB supports its proposal with the argument that reporting comprehensive income will clarify how well a business is doing, providing an indicator of future performance.
Although the FASB language is vague, one can surmise that the board believes that the three dangling items are truly revenues or expenses.
They presumably are not included in the income statement because they do not meet all the recognition criteria, particularly reliability, established by the FASB as being necessary for inclusion.
Opponents of the proposal claim that the above process merely shifts these unreliable numbers to comprehensive income. They assert that two income numbers will be confusing to the unsophisticated readers of financial statements.
They also state that comprehensive income is not relevant to investors and creditors.
But the strongest argument against the proposal is that it is unnecessary to those users who desire such information. Disclosure of the foreign currency adjustment, the minimum pension liability adjustment, and the unrealized holding gains and losses is sufficient to allow anyone to compute comprehensive income by themselves.
Two other items that are found in stockholders' equity for some entities are deferred compensation and unearned ESOP (employee stock ownership plan) shares. The FASB decided that these two items need not be included in comprehensive income because they involve ownership or capital transactions.
This is correct for ESOP transactions, as the employees are buying ownership interest in the firm. This treatment of deferred compensation, however, would be incorrect because compensation is clearly an expense.
How would this FASB proposal, if put into place, affect banks and bank holding companies? To get an idea, I obtained the numbers for 142 banks and adjusted net income for the three dangling items.
No company in the sample had an adjustment for minimum pension liability. Only six companies, mostly very large ones, had foreign currency adjustments. Unrealized holding gains and losses for the available-for-sale portfolio was the major adjustment for all the banks.
The impact on banks is relatively easy to determine.
In 1994, only three of the 142 banks had comprehensive income higher than net income, and only 12 banks had comprehensive income approximately equal to net income.
Thus, comprehensive income was lower than net income for 125 banks in 1994.
A total of eight banks had positive net income but negative comprehensive income in 1994. Chase Manhattan Corp. had the largest dollar difference: Its comprehensive income was almost $1 billion less than its net income.
The story in 1995 was cheerier, because most banks enjoyed holding gains during this period. Only three banks had lower comprehensive income; seven had about equal income numbers. So, 132 banks had higher comprehensive income than net income in 1995.
Norwest Corp. showed the greatest dollar difference, with comprehensive income $671 million higher than net income.
Several conclusions can be drawn from this analysis.
First, in the long run comprehensive income equals net income. The available-for-sale securities that give rise to unrealized holding gains and losses eventually mature or are sold, at which time realized holding gains and losses are recognized in net income.
Comprehensive income is more volatile than net income. The mean 1994 net income is $143 million while the mean 1995 net income is $160 million, an increase of $17 million or 12%. On the other hand, mean 1994 and 1995 comprehensive income is $105 million and $188 million respectively, a 79% increase.
Much of the holding gains and losses are due to marketwide effects. Virtually all firms had holding losses during 1994 (the mean loss was $39 million) but enjoyed holding gains during 1995 (mean gain was $28 million).
The specific amount obviously depends upon which securities make up the portfolio. But because the movement of individual securities is generally determined by the movement of the market as a whole, it is not surprising that the banks exhibited similar holding gains and losses.
What does it all really mean?
Comprehensive income is important because unrealized holding gains and losses are signals about future cash flows of the bank. Diligent investors, however, are already privy to the disclosures of these three adjustments and so can adjust stock prices accordingly. In short, comprehensive income provides no new information; it is merely repackaging information that has already been disclosed. It is likely, therefore, that the stock market will not react to comprehensive income numbers.
FASB makes a legitimate case that the three adjustments are indeed related to the earnings process and so should be included in the financial statements, but the adjustments themselves are easy for anyone to make. As long as banks disclose the adjustments, there is little need to enact this proposal.
So why did the FASB issue this proposal? Though we cannot be sure, it is instructive to remember the chief criticism put forth a decade ago when comprehensive income, incorporated within the conceptual framework, was seen as a backdoor approach to implementing current value income.
Holding gains and losses under current value accounting could be shielded from net income but would have to be included within comprehensive income. Proponents of current value accounting will tend to favor comprehensive income, while proponents of historical cost accounting, which includes most banks and bank holding companies, will not.
Mr. Ketz is an associate professor at Smeal College of Business at Penn State.
