Some time ago, standard IAS 1 Presentation of Financial Statements significantly changed and introduced the statement of other comprehensive income.

And then it began: lots of confusion, frustration and doubts! Many of us simply did not get the point and started to flounder in the fog. What items belong to OCI? What items belong to P/L?

This situation persists until now. Even in these days when I work with the client I see that she is not sure whether she is dealing with other comprehensive income or profit or loss.  And, how do the changes in equity fit in?

What is the difference between other comprehensive income and profit or loss? What is the difference between other comprehensive income and changes in equity?

Let’s bring it some light.

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The key is net assets

Surprised? It is as simple as that: the whole thing becomes clear when you focus on the net assets.

First, we need to understand what the net assets are.

Net assets are simply total assets less total liabilities of a company.

It is the same as equity which is the residual interest in the assets of an entity after deducting all of its liabilities.

 
NetAssets
 
As you can see above, if total assets are greater than total liabilities, then there is a positive equity or net assets.

In the opaque situation when total assets are lower than total liabilities, there is a negative equity or net assets.

What items belong to net assets?

Well, basically it is share capital, share premium, reserves, retained earnings or losses and some other items, too.
 

What can cause the change in net assets?

Net assets or equity can increase or decrease as a result of several things, for example:

  • shareholders contribute cash to the company
  • company makes a profit or loss
  • company buys own shares back from the market
  • company pays out the dividends to shareholders
  • company revalues certain assets directly through equity and not through profit or loss

The key to understand the difference between profit or loss, other comprehensive income and changes in equity is to understand where these changes are coming from.

 

So which statement to use?

We can classify changes in net assets or equity into 2 main categories:

  1. Capital changes – these are all changes related to introduction and return of capital to shareholders, such as:
    • Issuance of new shares
    • Paying out of dividends to shareholders
    • Buy-back of own shares from the market

    All capital changes must be reported in the statement of changes in equity.

  2. Performance changes – these are all changes coming from the activities of the company and not from the shareholders.

We can further divide this category into 2 subcategories:

i.      Changes resulting from or related to primary performance or main revenue-producing activities of the company that are reported in profit or loss. Here the following items fall:

  • Revenue from sales of goods or services
  • Expenses incurred to make sales of goods or services
  • All other income and expenses, such as finance, administrative, marketing, personnel, etc.
  • Gains related to primary performance (sale of property, plant and equipment, etc.)

The main point here is that other IFRS standard does not permit recognition of these changes directly to equity.

All these changes are reported in profit or loss.

ii.      Changes resulting from other, non-primary or non-revenue producing activities of the company that are not reported in profit or loss as required or permitted by other IFRS standard.

Here’s the list of them:

  • Changes in revaluation surplus related to property, plant and equipment (in line with IAS 16)
  • Actuarial gains and losses (in line with IAS 19)
  • Gains and losses arising from translating the financial statements of a foreign operation
  • The effective portion of gains and losses on hedging instruments in a cash flow hedge
  • Gains and losses on remeasuring available-for-sale financial assets (in line with IAS 39)
  • For financial liabilities designated as at fair value through profit or loss: fair value changes attributable to changes in the liability’s credit risk (IFRS 9).

This list is quite exhaustive and I really cannot think of other items that should potentially belong here. All these changes are reported in other comprehensive income.
 
 
OtherComprehensiveIncome
 
 

Follow these 2 steps

Step 1: Performance or capital change?

If you are not sure where certain item belongs, then think a while:

Is it performance change or capital change?

The reason for introducing other comprehensive income and merging it with profit or loss into the statement of comprehensive income was to distinguish between capital and performance changes.

The company needs to show clearly why its net assets go up or down – is it due to capital change? Or is it due to performance change?
 

Step 2: Allowed by other IFRS to OCI?

And then, if it is a performance change, is it from primary activity? Can we report it directly to equity in other comprehensive income – is it allowed by some IFRS standard or not?

If you answer these questions I’m sure you’ll never fall into trap of the wrong reporting and messing up individual components of your IFRS financial statements.