Other comprehensive income or OCI are those income, expenses, gains, and losses that the company is yet to realize. Since these are unrealized items, they do not appear in the income statement and thus, do not impact the profit or loss as well. OCI nomenclature and reporting are in accordance with the GAAP and IFRS.
An item is unrealized if the transaction is not complete yet. For instance, when you sell an investment, you realize a profit or loss from it. So, the transaction is complete. But, if you invest in shares, their value will keep changing until you sell them. So, the unrealized gain or loss you make on those shares without actually selling them is what comes under other comprehensive income. After you sell those shares and realize the gain or loss, then you shift the gain or loss from OCI to the income statement.
There is another similar concept, and it is Total Comprehensive Income. It is the sum total of other comprehensive income and the profit or loss or income from the income statement.
There could be two categories of OCI:
- OCIs that a company may later reclassify as the profit or loss.
- OCIs that a company will not reclassify as the profit or loss.
Other Comprehensive Income – What it Includes?
Other Comprehensive Incomes include the following items:
- Gains or losses from investments that a company classifies as available for sale.
- Losses or gains from the conversion of foreign currency.
- Gains or losses from the pension plan. If the value of the plan goes up, then the difference between the earlier and new value will come under the comprehensive income.
- Profit or loss from the derivatives instruments.
- Change in the value of an asset that is available for sale.
Importance of Other Comprehensive Income
The following points will help to bring out the importance of the other comprehensive income:
- The primary objective of OCI is to give the true financial position of a company to the stakeholders. This allows potential investors to make better decisions with regard to investing in the company. In a way, disclosure of OCI increases the transparency of financial statements.
- OCI helps to lower the volatility of net income. This is because the income statement excludes unrealized gains/losses, whose value moves up and down regularly.
- Understanding OCI can help analysts get an insight into the company’s investments.
- If a company has overseas operations, then studying OCI assists in understanding the company’s foreign operations and the impact of foreign currency.
- It also helps assess how a company’s future pension liabilities could impact its profits.
Talking about a drawback, many believe that the presence of the OCI items raises the complexity of the financial statements. Also, it may confuse investors’ who are not familiar with the OCI concept.
How to Report?
Other comprehensive income comes in a company’s balance sheet under the shareholders’ equity. After the company realizes the gain or loss from OCI terms, one must remove that item from the balance sheet and shift it to the income statement.
Also, one can prepare a consolidated statement of equity to properly list all the OCI items. Since OCI comes under the owner’s equity, we can also say that OCI represents a change in a firm’s equity during a period due to the non-cash gains and losses.
In a way, OCI items are similar to retained earnings. For instance, net income items impact the retained earnings, but the items that are not part of the net income impact the OCI.
Example of Other Comprehensive Income
In the financial statements, a company records investments at the historical value (not market value) on the balance sheet. The comprehensive income would adjust the value of the investment to its market value and put the difference under the equity section.
Now, let’s see an example to understand this concept better.
Company A buys an investment for $2 million at the start of 2020. This investment would reflect at the same price on the balance sheet. However, suppose at the end of 2020, the market value of the investment will rise to $2.2 million.
So, if a company puts the value of the investment at $2.2 million on the balance sheet, it would be misleading. Thus, the company would record a gain of $0.2 million as other comprehensive income.
Once Company A sells the investment for $2.2 million, it would reduce the increase in other comprehensive income by $0.2 million and the record the same in the income statement as well.
When a company classifies items as other comprehensive items, they do it on the basis of GAAP and other applicable accounting standards, like IFRS. Basically, OCI includes items with unrealized gains or losses. Thus, they help to increase the overall transparency. However, OCI items increase accountants work and could be time-consuming and, at times, confusing as well.