The Importance of Other Comprehensive Income

Other comprehensive income (OCI) is a term used in business accounting to define transactions that aren’t yet realized. These figures include revenues, expenses, gains, and losses—all of which are excluded from the net income on a company’s income statement. OCI is an important figure because it can provide more insight into a company’s financial health and its overall value.

Understanding Other Comprehensive Income (OCI)

Other comprehensive income is an expansive view of net income because it includes revenues, expenses, gains, and losses. As noted above, these figures are recognized but aren’t yet realized. Although they contribute to a company’s profitability, they aren’t included in its net income.

This figure is key because it provides insight into a company’s financial health. The items included in OCI don’t relate to a company’s central operations but have an impact on its equity. Put simply, they don’t immediately affect a company’s bottom line on a cash basis.

The Financial Accounting Standards Board (FASB) requires companies to report their OCI separately from their net income on their financial statements. You can find it as a separate line item on the balance sheet under the equity section as accumulated other comprehensive income.

Companies can also present OCI in their financial statements as individual line item components along with the income statement (such as in the footnotes of the income statement) or present on a separate page. These measures are also part of a long-term goal to help the U.S. generally accepted accounting principles (GAAP) align more closely with International Financial Reporting Standards (IFRS) as administered by the International Accounting Standards Board (IASB).

Important Categories of Other Comprehensive Income (OCI)

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 that impact a company’s bottom line.

Investment Gains and Losses

Insurance companies, banks, and other financial institutions have large investment portfolios. As such, realized gains and losses are going to run through reported net income for the most part. But, the unrealized side of the equation demonstrates how a company manages its investments and if there is the potential for big losses down the road. OCI can help an analyst get to a more accurate measure of the fair value of a company’s investments.

Currency Exchange

Looking at OCI can also lend insight into firms that operate overseas and do currency hedging or have sizable overseas revenues. For instance, a foreign currency adjustment may not be overly large, but seeing it could 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.

Pension Plans

Another major category in OCI is the impact on corporate retirement plans. Low interest rates have put the pension assets of some large corporations’ plans 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.

The extent of future retirement liabilities is certainly an important consideration in estimating a firm’s future profit prospects. For instance, Goodyear reported a standard net income of $343 million, but a loss of $378 million when subtracting retirement plan expenses in 2011. That same year, General Electric logged regular earnings of almost $14.2 billion but had those more than cut in half when factoring in losses on its retirement plans.

Other Categories

The OCI measure also helped during the 2008 financial crisis and through its recovery. Bank of America reported a $1.4 billion profit on its standard income statement coming out of the Great Recession with a loss of $3.9 billion based on comprehensive income. The difference stemmed from OCI and unrealized losses in its investment portfolio. It called into question the quality of the profit figures it held out as its real measure of capital generation for the year.

“In response to the financial crisis of 2008, under Basel III regulations, unrealized gains and losses on available-for-sale (‘AFS’) securities recorded in accumulated other comprehensive income became included in banks’ regulatory capital for advanced approaches banks,” according to Columbia Business School professors Sehwa Kim, Seil Kim, and Stephen Ryan.

“As a result, recent studies find that those affected banks reclassified investment securities from AFS to held to maturity (HTM) or classified newly acquired securities as HTM to mitigate the increase in regulatory capital volatility. These studies suggest that OCI can be a significant factor affecting financial institutions’ asset portfolio management.”

Other Comprehensive Income (OCI) vs. Comprehensive Income

Although they sound the same, OCI isn’t the same as comprehensive income. Comprehensive income simply combines standard OCI and net income. As such, it is 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.

In June 1997, the FASB issued FAS130 on how to report comprehensive income. 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 non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.”

Real-World Example of Other Comprehensive Income (OCI)

To better illustrate the specific components of OCI, let’s look at a statement from MetLife. In 2012, one of its 10-K filings with the Securities And Exchange Commission (SEC) detailed standard net income of $6.7 billion as well as accumulated other comprehensive income of around $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 $109 million, and defined benefit plan adjustments of negative $494 million.

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 astute analysts can combine both statements in their 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.