The U.S.

The controversy regarding the definition and reporting o f income has a long history in the U.S. accounting standard-setting process. According to K iger and Williams (1977), during the period between 1940 and 1975 U.S. accounting standards moved from an all-inclusive approach to an extreme position o f current operating performance, to end in a moderate concept closer to the all-inclusive. The Accounting Research Bulletin (ARB) 8: Combined Statement o f Income and E arned Surplus, issued in 1941 by the Committee on Accounting Procedures o f the AIA (currently the AICPA), showed a clear preference for a comprehensive income:

‘...Over the years it is plainly desirable that all costs, expenses, and losses of a business, other than those arising directly from its capital stock transactions, be charged against income’.

The AR B 32, issued in 1947, defended a similar position but determined that material items not identifiable with typical business operations were to be excluded from net income. Special items should either be presented in the income statement following the am ount labelled as net income or in the statement o f retained earnings. This mixed position reveals an intention to include all items in income but to have at the same tim e an operating measure o f income. The ARB 35 (1948) and ARB 41 (1951), further revealed a preference for an operating performance concept, where it was argued that net income should not include items such as extraordinary items and contingency reserves and the most prominent figure in the income statement should reflect operating performance. ARB 43: Restatement and Revision o f Accounting Research Bulletins Nos. 1 - 42 (1953) followed the position expressed in ARB 35 and ARB 41.

A lthough accepting the inclusion of special items in the income statement, the

Committee indicated a preference for their presentation in the statement o f retained earnings.

The next standard issued on this topic was Accounting Principles Board Opinion (APB) 9: Reporting the Results o f Operations, issued in 1966. This pronouncem ent defined two levels o f income: ‘income before extraordinary item s’ and ‘net incom e’ to be placed at the bottom o f the income statement with extraordinary items between them. This way, net income moves closer to the all- inclusive concept (prior-year adjustments are excluded from income) while users can still obtain a figure o f income on the basis o f operating activities. But in practice companies reported extraordinary items and other special items in a variety o f ways leading to considerable public discontent. Kiger and W illiams (1977) analyse com panies’ reporting practices regarding special items during the period 1953 to 1966 and find that presentation o f special items varied considerably. At the end o f the period, 70% o f companies reported the special items in the income statement while the rem ainder reported in the retained earnings statement. The companies that chose the income statement disclosed special items in various ways: (1) among other income items but disclosed separately, (2) aggregated with other income items but reported in notes and descriptive sections o f the financial reports, (3) in a separate section in the income statement before net income, and (4) in a separate section in the income statement but after net income. In order to improve the concept o f income, the APB issued opinions APB 20: Accounting Changes (1971) and APB 30: Reporting the Results o f Operations. Reporting the Effects o f Disposal o f a Segment o f a Business and Extraordinary, Unsual and Infrequently Occuring Events and Transactions

(1973). These standards introduced the following changes: corrections o f errors in previous financial statements constituted a prior period adjustment; a new figure o f

‘net income from continuing operations’ was created; extraordinary items were defined in a more specific way; and discontinuing operations were to be included in net income before extraordinary items.

The FASB, the successor o f the APB, made another step towards comprehensive income with SFAS 8: Accounting fo r the Translation o f Foreign

Currency Financial Statements (1975) and SFA S 16: Prior Period Adjustments

(1977). W ith these two statements, the regulator changed the definition o f prior-year adjustments as defined in APB 9 and established that all items recognised during the period (with some exceptions) should be presented as part o f net income.8 At the same time, the concept o f comprehensive income was formally introduced in accounting standards in a way consistent with the all-inclusive philosophy via SFAC 3: Elements o f Financial Statements o f Business Enterprises (1980). This statement was later replaced by SFAC 6: Elements o f Financial Statements (1985).

The concept o f income introduced in the statements discussed above gave rise to some debate regarding the components o f net income, namely gains and losses resulting from currency translation, accused o f introducing volatility in reported earnings. The FASB response appeared in 1981 with SFAS 52: Foreign Currency Translation, which allowed gains and losses resulting from currency translation to be taken to shareholders’ funds rather than being included in net income. According to W alsh (1995), this turnaround o f the all-inclusive concept o f income expressed in

SF A S 8 had important implications. First, it linked the debate with the concepts o f income measurement and capital maintenance defined in SFAC 3. Second, it created a precedent for direct entries to owners’ equity. In fact, SFAS 87: E m ployers’

8 The only gains and losses included directly in shareholders’ funds were: (1) holding gains and losses recognised as part o f quasi-reorganisation; (2) corrections o f errors in the financial statem ents o f a prior period; (3) adjustments arising from the realisation o f tax benefits o f pre-acquisition operating loss carry forw ards o f purchased subsidiaries; (4) items associated with certain industry specific accounting practices; and (5) adjustments arising from certain changes in accounting method (W alsh, 1995).

Accounting fo r Pensions (1985) and SFAS 115: Accounting fo r Certain Investments in D ebt and Equity Securities (1993)9, permitted certain pension adjustments and gains and losses on marketable securities to be written o ff to shareholders’ funds. Furthermore, in the framework o f the time, the FASB project on financial instruments, which resulted in SFAS 133: Accounting fo r Derivative Instruments and Hedging Activities (1998), would introduce new dirty surplus flows. About the same time, users

o f financial statements revealed some discontent about the amount o f transactions bypassing the income statement. In 1993, the Association for Investment M anagement and Research (AIMR), one o f the most influential user groups o f financial statements according to Johnson, et al. (1995), issued a report expressing concerns about the increasing number o f transactions bypassing the income statement. They proposed the introduction o f comprehensive income and the disclosure o f the components o f comprehensive income. This position coincided with concerns expressed in the accounting research literature about the value-relevance o f reported income and the possibility that the components o f income have different predictive ability about future payoffs (Johnson, et al., 1995). Internally, the FASB was also suffering pressures stemming from the project on financial instruments. Some members were concerned with the amount o f transactions on financial instruments reported ‘off- balance sheet’ and intended to bring them into the financial statements. However, because these transactions were to be recognised at fair value, the impact in the financial statements could be dramatic. In response to these claims and considerations, in 1995 the FASB introduced in its agenda a project on reporting comprehensive income that later gave rise to SFAS 130: Reporting Comprehensive Incom e, applicable for fiscal year-ends beginning after 15 December 1997. The project assumes the

^ Follow ing the previous SFAS 12: Accounting fo r Certain M arketable Securities, issued in 1975.

existing definition and measurement o f comprehensive income and focuses on the question o f presentation o f comprehensive income (Johnson, et al., 1995). A similar approach had been used earlier in the U.K. with the introduction o f the Statement o f Total Recognised Gains and Losses. SFAS 130 requires that comprehensive income and its components should be reported in a financial statement that is displayed with the same prominence as other financial statements that are part o f a full set o f financial statements. Preference was given to the display in the income statement below net income or in a separate statement o f comprehensive income, which begins w ith net income. Alternatively, the changes in components o f comprehensive income can be presented in the statement o f shareholders’ equity. Under SFA S 130, the components o f comprehensive income are: (1) unrealised gains and losses related to marketable securities, (2) foreign currency translation differences and (3) changes in additional minimum pension liability in excess o f unrecognised prior service costs.