Description
This paper aims to understand the effects of different presentation formats on
nonprofessional investors’ judgments. Both International Financial Reporting Standards and US
Generally Accepted Accounting Principles require an entity to present items of net income and other
comprehensive income (OCI) either in one continuous or in two separate, but consecutive, statements
but limited understanding exists about their differential effects on evaluation of company performance.
Accounting Research Journal
The effects of comprehensive income on investors’ judgments: An investigation of
one-statement vs. two-statement presentation formats
Ning Du Kevin Stevens J ohn McEnroe
Article information:
To cite this document:
Ning Du Kevin Stevens J ohn McEnroe , (2015),"The effects of comprehensive income on investors’
judgments", Accounting Research J ournal, Vol. 28 Iss 3 pp. 284 - 299
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The effects of comprehensive
income on investors’ judgments
An investigation of one-statement vs.
two-statement presentation formats
Ning Du, Kevin Stevens and John McEnroe
School of Accountancy and MIS, DePaul University, Chicago, Illinois, USA
Abstract
Purpose – This paper aims to understand the effects of different presentation formats on
nonprofessional investors’ judgments. Both International Financial Reporting Standards and US
Generally Accepted Accounting Principles require an entity to present items of net income and other
comprehensive income (OCI) either in one continuous or in two separate, but consecutive, statements
but limited understanding exists about their differential effects on evaluation of company performance.
Design/methodology/approach – To investigate this research question, we used a two (Financial
Position) x two (Format) randomized between-subjects experiment. Ninety-four graduate students
assumed the role of investor and participated in this study.
Findings – Results of the experiment suggest that participants are more likely to incorporate OCI
information presented in the one-statement format than in the two-statement format. Further analysis
suggests that participants both assign more weight to OCI and perceive OCI to be relatively more
important in the one-statement format than in the two-statement format, especially when the entity
suffers an economic loss.
Originality/value – Results fromthis study provide evidence to the Financial Accounting Standards
Board and International Accounting Standards Board that should be useful in evaluating the
effectiveness of alternative comprehensive income reporting formats and should be of interest to
accounting rule-making bodies, investors, publicly traded entities and fnancial analysts, among others.
Keywords Judgment, Assimilation, Net income, Other comprehensive income,
Nonprofessional investors
Paper type Research paper
1. Introduction
Both the International Accounting Standards Board (IASB) and the Financial
Accounting Standards Board (FASB) currently require frms to disclose other
comprehensive income (OCI) in a performance-based reporting option and allow the
choice of reporting OCI either in one continuous statement (i.e. the statement of
comprehensive income) or in two separate, but consecutive, statements. US Generally
Accepted Accounting Principles (US GAAP) has historically allowed comprehensive
income (CI) to be reported in a nonperformance-based statement such as stockholders’
equity. Given the ample evidence suggesting that managers strategically choose the
equity format option for self-serving reasons (Bamber et al., 2010; Hunton et al., 2006; Lee
et al., 2006), it is not surprising that, in June 2011, the US FASB eliminated that format
and achieved convergence of guidance on the CI presentation between US GAAP (see
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1030-9616.htm
ARJ
28,3
284
Received15 November 2013
Revised14 May2014
11 August 2014
Accepted21 August 2014
Accounting Research Journal
Vol. 28 No. 3, 2015
pp. 284-299
©Emerald Group Publishing Limited
1030-9616
DOI 10.1108/ARJ-11-2013-0083
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Accounting Standard Codifcation (ASC) Topic 220) and International Financial
Reporting Standards (IFRS; see IAS 1, 2010, Presentation of Financial Statements).
Prior research on OCI mostly examines the difference between a performance-based
statement (e.g. the two-statement option) and a nonperformance-based statement (i.e.
owner’s equity). This study focuses on the performance-based option and examines the
difference between the one-statement and two-statement formats. In spite of reporting
the same total OCI number, these two formats present the OCI information in different
locations. Unlike the one-statement format, which combines net income (NI) and
components of OCI in one continuous statement, the two-statement approach, by
leaving the income statement in its current form, adds a second statement which reports
the components of OCI. Because the one-statement format tends to bury NI within CI (i.e.
a subtotal in the middle of a continuous statement of CI), many have criticized the
one-statement approach for awarding NI and OCI the same prominence in the income
statement in spite of their conceptual differences. Therefore, we want to understand
whether, compared to the two-statement approach, the one-statement presentation of
OCI may increase the salience of OCI while diminishing the importance of NI. In other
words, will the one-statement format, by presenting the NI and OCI in close proximity,
draw investors’ attention away from NI as the “bottom line” of a business and affect
nonprofessional investors’ evaluation of a company’s fnancial performance?
OCI is conceptually different from NI; NI summarizes the current fnancial
performance results of operating a company and is a clear indicator of current fnancial
performance, but OCI presents information about a company’s potential income and
cash fows fromtransactions generally to be fnalized sometime in the future. Because of
its complexity, determining how to use and/or how much to use the OCI information is
not an easy task, especially for nonprofessional investors. As argued by Maines and
McDaniel (2000), because nonprofessional investors are limited in their understanding
of fnancial analysis, the format of the fnancial statement is important in that it provides
signals about the nature and importance of CI information (Maines and McDaniel, 2000,
p. 10). Thus, the location of OCI becomes an important cue for assessing the importance
of OCI information when investors evaluate a company’s fnancial performance.
Based on the inclusion-exclusion model in the psychology literature (Schwarz and
Bless, 1992), we argue that investors are more likely to incorporate OCI in their
evaluations of fnancial performance when OCI is represented in the one-statement, than
the two-statement, format. To test these hypotheses, we use a two (fnancial position) x
two (format) randomized between-subjects experiment. We manipulate fnancial
position as gain or loss of CI, and we manipulate format as one (continuous) statement or
two (separate) statements. Ninety-four graduate students assumed the role of investors
and participated in this study. Results of the experiment suggest that higher perceived
fnancial performance is related to the one-statement format, potentially because of the
close proximity of OCI and NI, which may have led to a higher assigned weight to OCI
in the performance evaluation. This effect is particularly strong when the company
suffers a fnancial loss.
This study contributes to the prior literature in several ways. First, this investigation
extends prior research on the reporting format of CI. Unlike prior studies, which tend to
focus on comparing the performance option and the nonperformance option, we
investigate the subtle differences between performance-based options. Our results
suggest that despite both being performance-based, the two currently allowed OCI
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presentation formats may lead to different judgments among nonprofessional investors.
In addition, we fnd that the format effect is quite complex: though investors may prefer
the clarity of one continuous statement, the one-statement reporting format may dilute
the focus on NI as the most important performance measure of a company. Moreover,
this study extends Maines and McDaniel (2000) by providing evidence about how the
location of OCI information affects nonprofessional investors’ differential weighting of
OCI information across the different performance-based statement. Lastly, the results
fromthis study are timely and provide evidence to the FASBand IASBin evaluating the
effectiveness of alternative CI reporting formats and should be of interest to accounting
rule-making bodies, investors, publicly traded entities and fnancial analysts, among
others.
2. Literature review and hypothesis development
2.1 History of CI
Prior to 1997, OCI was not required to be reported anywhere in the fnancial statements,
and many of its components bypassed the income statement and went directly to
owners’ equity. In 1997, the FASB issued SFAS 130 (ASC Topic 220), Reporting
Comprehensive Income (FASB, 1997), requiring companies to report and display CI and
its components in a primary fnancial statement. FAS 130 (ASC Topic 220) defnes CI as
consisting of NI and OCI. Other Comprehensive Income refers to revenues, expenses,
gains and losses that under US GAAP are included in CI but excluded from NI (i.e.
unrealized holding gains and losses on available for-sale securities, additional minimum
pension liability adjustments, currency translations, gains and losses of cash fow
hedges and asset revaluations). In 2007, the IASBpublished a revised version of the IAS
1 – Presentation of Financial Statements to bring OCI into line with the reporting
requirement of SFAS 130. Figure 1 presents a diagramillustrating the timeline of events
regarding OIC formats.
CI is derived fromthe concept of an all-inclusive income statement which refers to all
the changes in assets and liabilities other than those that involve transactions with
owners. It satisfes the desire of fnancial statement users for one fgure, which includes
all components of income that lead to changes in the overall fnancial position of
organizations. Statement of Financial Accounting Concepts No. 6 (SFAC 6, 1985),
Elements of Financial Statements, defnes CI as:
[…] the change in equity 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 distribution to owners.
The concept of CI is closely related to the “clean” vs “dirty” surplus concept. Under the
clean surplus approach, all income items must pass through the income statement; they
sometimes are referred to as items that are reported above the line (the NI line). Thus,
earned surplus (equivalent to retained earnings) was “clean” of these items (Lee et al.,
2006). Under the dirty surplus approach, certain items bypass the income statement and
are directly reported in the statement of owners’ equity. These items were given the
name “Other Comprehensive Income (OCI)”. Accordingly, the notion of dirty surplus
includes items that are reported below the NI line.
The lack of a conceptual defnition of the difference between NI items and OCI items
creates the OCI controversy. Most transactions recorded in OCI refect changes in the
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fair value of various assets and consist mostly of unrealized gains or losses driven by
external market factors. Thus, CI measures cash fow plus changes in net asset value.
Even though future income and cash fows are valuable information, nonprofessional
investors may not understand the nature of OCI and may have diffculty in viewing it as
a reliable performance measure. Recent standards, such as those on fnancial
instruments and post-employment benefts, increase the prominence of fair value as the
primary measurement attribute and thus expand the use of OCI. For example, requiring
companies to record changes in fair value for many fnancial instruments (including
most loans and issued debt) through OCI magnifes the difference between NI and OCI
in the fnancial statements. However, the more important conceptual issues such as
whether OCI is a performance measure, and concomitantly, what the items included in
OCI are intended to represent (i.e. whether they fulfll the criteria of income or expense
or, rather, represent other non-owner changes in equity) remain problematic and
controversial. Not surprisingly, the lack of a clear conceptual defnition of what should
be reported in NI and what should be reported in OCI complicates the decision processes
of fnancial statement users. For example, despite recent convergence efforts, the FASB
and the IASB differ sharply in reclassifying (recycling) OCI items into NI. Under US
GAAP, amounts initially recognized in OCI are reclassifed eventually into proft or loss,
In 1997, the FASB issued
SFAS 130 (ASC Topic
220), requiring OCI to be
reported in one-statement,
two-statement or the
owners’ equity format.
In 2007, the IASB
published revised
IAS 1—
Presentation of
Financial
Statements,
requiring OCI to
be reported in
one- statement or
two-statement
In 2011, the FASB issued
ASU No. 2011-05 to
amend SFAS 130 (ASC
220), eliminating the
equity option for CI
reporting and requiring
OCI to be reported in one-
statement or two-
statement
Figure 1.
Timeline of events
regarding OCI
reporting
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whereas under IFRS different items are reclassifed in different ways (e.g. actuarial
gains and losses related to employee beneft plans recognized initially in OCI are not
reclassifed into proft or loss).
2.2 OCI reporting formats
The presentation of CI has always been controversial. In 1997, the FASB issued SFAS
130 (ASC Topic 220) which specifed three options for reporting CI: one-statement,
two-statement or the equity format. The one-statement (combined statement of income
and CI) format displays the components of OCI belowthe NI total in a traditional income
statement. The two-statement approach presents each component of OCI in a separate
statement of CI that begins with NI. Both formats end with the same total CI. The equity
format, the most popular approach among corporate managers, reports CI as part of the
statement of changes in stockholders’ equity. While all three options were acceptable,
the FASB encouraged reporting OCI in the performance-based statement employing
either the one- or two-statement format and discouraged the use of the equity format
because, as the FASB concludes, the equity format lacks transparency by “hiding” CI in
a nonperformance-based statement. However, the IASBdid not give companies as much
discretion as the FASB. In the revised IAS 1 (2007), IASB only allows the use of
performance-based reporting format to report OCI, i.e. the one-statement or
two-statement presentation but does not permit the equity option. On June 16, 2011, the
FASB (2011) issued Accounting Standards Update No. 2011-05, Presentation of
Comprehensive Income to amend ASC Topic 220, Comprehensive Income. This standard
eliminates the option to present items of OCI in the statement of changes in stockholders’
equity, but allows the choice of presenting items of NI and OCI either in one continuous
statement (i.e. the statement of CI) or in two separate, but consecutive, statements.
2.3 Prior academic research on OCI
Accounting researchers have been interested in understanding the effects of CI and its
presentation on users of fnancial statements. Prior archival researchers have examined
company’s actual choices in selecting CI reporting formats. Jordan and Clark (2002) and
Pandit and Phillips (2004) fnd the majority (more than 60 per cent) of the companies
used the equity option, followed by the one-statement format and then fnally, the
two-statement format. In addition, their evidence shows that companies with negative
OCI were more likely to adopt the equity option, implying that managers choose a
nonperformance-based fnancial statement such as stockholders’ equity to “bury” the
loss in equity rather than having the loss prominently displayed in the income
statements.
Another streamof archival research focuses on the effects of presentation formats of
OCI information on the entity’s market return; however, the results are inconclusive. For
example, some studies fnd that CI is more relevant than NI as a performance indicator
because of its stronger correlation to stock return than NI (Biddle and Choi, 2006; Cahan
et al., 2000; Chambers et al., 2007). In contrast, Dhaliwal et al. (1999) documented no
evidence of a strong association between CI and US stock market returns. In a more
recent study, Bamber et al. (2010) investigated a broad cross-section of frms and fnd
that over 80 per cent of their sample S&P 500 frms report CI in the statement of equity.
They conclude, managers with stronger equity-based incentives and less job security
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are concerned about volatility in CI when it is reported in the income statement, and,
thus, prefer the equity option.
Behavioral researchers focus on the differential effects of reporting formats on the
judgments of fnancial statement users such as analysts and individual investors.
Hunton et al. (2006) examine whether the display of CI affects managers’ selective sale of
available-for-sale (AFS) securities to manage earnings. In their study, fnancial
executive participants prefer the less transparent equity format for earnings
management (EM), but when the authors require participants to report total CI in a
single continuous statement, participants are reluctant to engage in EMattempts. With
a focus on fnancial analysts’ stock valuations, Hirst and Hopkins (1998) compare the
equity to the two-statement approach. They fnd that analysts fail to identify unrealized
gain and loss (UGL) information for AFS when this information is presented in a
statement of stockholders’ equity, but that the reporting of UGL in a separate
two-statement of CI enhances fnancial analysts’ ability to detect EM through selective
sale of AFS.
Maines and McDaniel (2000) argue that the reporting format of CI is unlikely to affect
the judgments of more sophisticated market participants, such as fnancial analysts,
because analysts understand the role of CI in frm evaluation and will conduct an
extensive search for this information (Hunton and McEwen, 1997). In contrast, Maines
and McDaniel (2000) investigate nonprofessional investors’ responses to different CI
reporting formats. Ninety-fve MBA students participated in their study and analyzed
an insurance company’s fnancial statements which included low and high volatility
produced by unrealized gains of AFS market securities. They fnd that participants are
sensitive to the negative effects of volatility on corporate and management performance
and placed signifcant weight on volatility when OCI is presented in a separate
two-statement format but not when it is in an equity format. They conclude that
the reporting format has no effect on investors’ acquisition and evaluation of OCI
information but does have an effect on the weighting of OCI information. In summary,
prior studies focus on the equity option, but none of the above studies investigates the
differences between the one-statement and two-statement formats.
2.4 Hypotheses development
In both one-statement and two-statement formats, the NI and OCI are shown together as
components of CI, included in the same CI category, and summed with the total
presented; however, the two formats differ signifcantly in where the information is
presented. Specifcally, the one-statement format presents the breakdown of OCI
directly after the NI number, and both NI and OCI information is often presented on the
same page and appears in a continuous statement. In contrast, in the two-statement
format, the NI statement and the statement of CI (the second statement) are often
presented on different, separate pages. In a recent study, Hodge et al. (2010) examine
fnancial statement format effects with a focus on information proximity. Guided by the
proximity compatibility principle, they predict users will more effective and effciently
integrate fnancial information that is presented in close proximity such as on a single
statement (or page) rather than on separate statements (Wickens and Carswell, 1995;
Carswell and Wickens, 1996). In their study, they presented fnancial information such
as cash fow and non-cash assets to graduate accounting students, and found that
presenting information on a single page results in reduced forecast errors and faster
289
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learning in forecasting future cash fow. Results fromHodge et al. (2010) suggest that the
choice of reporting OCI in the one-statement versus the two-statement format will affect
investors’ judgments because these two formats differ in their information proximity.
The effects of information proximity can be explained by the Inclusion-Exclusion
Model proposed by Schwarz and Bless (1992 and 2007). That is, the way a piece of
information infuences judgments depends on how it is categorized. The
Inclusion-Exclusion Model holds that assimilation effects result when the stimulus
information is included in the temporary representation that individuals form of the
target category; thus, judgment refects the information that is included in the
representation used. For example, the addition of some positive information results in a
more positive judgment, whereas the addition of some negative information results in a
more negative judgment. Because individuals do not retrieve or use all knowledge, but,
rather, rely on the subset of potentially relevant information that is most accessible at
the time of judgment, the categorization of information is susceptible to contextual
infuences. One such infuence is the boundary of information. The inclusion-exclusion
model argues that fuzzier boundaries of stimulus and target, or a shorter distance
between these two, would promote assimilation because closeness implies that both
stimulus and target belong to the same category, and, therefore, increases the likelihood
of inclusion, whereas stronger boundaries and greater distance would lead to the
opposite effect. Evidence from prior accounting research also supports the linkage
between fexible categorization and fuid information assimilation. For example, Lipe
and Salterio (2000) document that direct links between information items help
decision-makers mentally “chunk” these items, thereby increasing the weight placed on
the items in forming judgments. Hopkins (1996) documents that fnancial analysts use
accounting classifcation to interpret information. In particular, his evidence suggests
that whether hybrid fnancial instruments are categorized as a liability or owners’
equity affects fnancial analysts’ common stock valuations.
Similarly, we argue that the placement and location of OCI affects how investors
categorize OCI information, in other words, whether or not they classify OCI in the
category of a performance measure. We propose that OCI is more likely to be assimilated
into the category of performance measure in the one-statement format because of its
close proximity to NI. Investors are familiar with the traditional income statement
format. When OCI is added directly below the NI in a traditional income statement,
investors are more likely to viewOCI to be a similar measure as NI and, thus, categorize
OCI as a performance indicator. On the contrary, when OCI is included in a separate
statement, investors may have diffculty in classifying the nature of the indicator and
will not be sure whether it indeed belongs to the traditional income statement. Thus, OCI
in the two-statement format is less likely to be viewed as a similar measure to NI and,
therefore, will be less likely to be judged as performance related. Assuming a company
has positive OCI because of unrealized gains, if OCI is viewed as a performance measure,
the OCI will cast a more positive light on the company’s operations regardless of their
profts or losses in operating income. Therefore, our Hypothesis 1 focuses on the impact
of positive OCI information on investors’ evaluation of fnancial performance:
H1. Nonprofessional investors are more likely to judge that a company has higher
fnancial performance when positive OCI information is presented in the
one-statement format than in the two-statement format.
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Nonprofessional investors have relatively ill-defned valuation models (Maines and
McDaniel, 2000); thus, most of themlack a clear understanding of the difference between
NI items and OCI items and are not sure to what extent to rely on OCI in their
performance evaluation. In their study, they fnd that alternative OCI presentation
formats affect nonprofessional investors’ weighting of volatility information. Similarly,
we argue that when individuals form a judgment about operating results based on NI,
they construct a mental representation of corporate performance; the close association
between OCI and NI implies that both items belong to the same category which, in turn,
increases the likelihood of including OCI in a mental representation of the performance
judgment. Thus, the second hypothesis focuses on the weight assigned to OCI by
investors across different formats:
H2. Nonprofessional investors assign greater weight to OCI in the one-statement
format than in the two-statement format.
3. Method
3.1 Participants
The participants are 94 graduate students from a large private university in the USA.
These students are currently enrolled in the master of accounting program. We recruited
the students in their intermediate accounting course. Students volunteered to participate
in response to in-class announcements for extra course credit. Demographic information
collected at the end of the experiment indicates that most participants are likely to have
the necessary knowledge and experience to complete the task. For example, the majority
of participants have both work and investment experience. On average, participants
have about 1.83 years of working experience and 1.07 years of investment experience.
We also ask themto indicate howmuch knowledge they have about CI. The mean rating
is 5.52 on an 11-point scale (1 being very little, 11 being a great deal). The rating of 5.52
suggests that participants are not confdent about their understanding of OCI, a result
we surmise refects the general competence of individual nonprofessional investors.
Among the participants, 24 are males and 70 are females, representative of the graduate
school cohort. Despite the difference in gender numbers, we do not perceive this to affect
the results of our study (a MACOVA analysis indicates that the gender factor is not
signifcant).
3.2 Procedure and task
In the experiment, we asked the participants to assume the role of investor. Their task
was to evaluate the provided fnancial statements and assess the fnancial performance
of XYZ Company. The fnancial statements included NI and CI information, and were
constructed from OCI examples in PWC Dataline (www.pwc.com). In addition, the
instruction provides a short explanation about the difference between CI and NI by
including the following paragraph:
Comprehensive income includes both Net Income and Other Comprehensive Income. Net
income summarizes the current fnancial results of operating a company and refects complete
transactions (or nearly complete) that produce currently available net earnings and cash fows
for use by a company’s management. However, most transactions recorded in Other
Comprehensive Income refect changes in fair value and consist of unrealized gains or losses
driven by external market factors. Other Comprehensive Income consists of long-termand less
recurring items and may or may not affect future cash fows of an entity. In other words, Other
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Comprehensive Income eventually may or may not be realized as Net Income in the future.
Unlike the Statement of Net Income, the Statement of Comprehensive Income includes both net
income and other comprehensive income.
After reviewing the provided information, participants made a series of judgments
about Company XYZ. Finally, participants fnished by answering a short series of
manipulation check questions and were debriefed. The entire experiment took 20
minutes on average to complete.
3.3 Independent variables
We use a two (fnancial position) x two (format) between-subjects design. The fnancial
position variable is manipulated at two levels (gain or loss) and the format variable at
two levels (one-statement or two-statement). Participants are randomly assigned to
experimental conditions. We manipulate fnancial position as gain or loss of CI. The loss
condition is included for two reasons:
(1) to ensure that the predicted effects are consistent across profts and losses; and
(2) to ensure participants attend to the experimental stimulus and the differential
between gains and losses.
We achieve this by holding OCI constant at $840,000 but varying proft or loss in the
income statement. Both conditions have the same revenue of $3,550,000. We create a
mirror image of proft or loss by varying the expense section, with a NI of $1,400,000 for
the gain condition and a net loss of $1,400,000 in the loss condition. Thus, we have a CI
of $2,240,000 in the gain condition and $560,000 in the loss condition.
We manipulate the format variable as one continuous statement or two separate
statements. In the one-statement condition, OCI follows directly after NI and earnings
per share. The heading reads as “Statement of Comprehensive Income (XYZ Inc.) for
Year ended December 31, 2011”. All information is presented on one single page. The
two-statement condition contains two separate pages. The frst page includes
“Statement of Net Income for Year ended December 31, 2011”. The second page includes
“Statement of Comprehensive Income for Year ended December 31, 2011”, which starts
with NI, followed directly by OCI. In both formats, the total of CI is presented at the end
of the statements.
3.4 Dependent variables
Dependent variables include the strength of fnancial performance and percentage
weight assigned to OCI. We also collected judgments on the degree of relatedness
between NI and OCI and the importance of OCI.
4. Results
4.1 Manipulation checks
To check the fnancial position and format manipulation, we ask participants to
examine the received information and list the amounts of NI or loss, OCI or loss and total
CI or loss for XYZ Inc. All participants identifed the right amounts in their assigned
conditions.
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4.2 Multivariate analysis of covariance
As the four dependent variables are potentially correlated, we rely on multivariate
analysis of covariance (MACOVA) for the initial analysis. First, we examine the
assumption of equality of covariance matrices across treatment groups. The Box
statistic is signifcant with a Box’s M of 73.72 (F ?2.26, p ?0.05). However, we are not
concerned with violations of the equality assumption, because of our approximately
equal group sizes (Hair et al., 1998, p. 348). Thus, we proceed to the MACOVA analysis.
To control for any potentially extraneous infuence on dependent variables, we include
gender, investment experience, work experience and the ratings on self-knowledge of
OCI as covariates in our analysis. The results of MACOVAare presented in Table I and
show that both independent factors are signifcant. Wilks’ lambdas are 0.82 (F ?4.90,
p ? 0.01) for format and 0.41for gains or loss (F ? p ? 0.01). Their interaction are
marginally signifcant (Wilks’ lambda ? 0.91, F ? 2.06, p ? 0.09). In addition,
MACOVA indicates none of the four control variables is signifcant. Specifcally, for
self-knowledge, Wilks’ lambda is 0.95 (F ?2.85, p ?0.05); for work experience, Wilks’
lambda is 0.94 (F ? 2.64, p ? 0.05); for investment experience, Wilks’ lambda is 0.96
(F?1.63, p ?0.05); for gender, Wilks’ lambda is 0.95 (F?1.92, p ?0.05). Because of the
signifcant results of our independent variables, we follow up with analysis of variance
(ANOVA) for each of the dependent variables.
4.3 ANOVA
H1 predicts that nonprofessional investors are more likely to judge higher fnancial
performance when positive OCI information is presented in the one-statement format
than in the two-statement format. To test this hypothesis, we asked participants to
answer the question on an 11-point scale (1 being very weak, 11 being very strong):
“How strong is the company’s fnancial performance?” The mean ratings for fnancial
performance are provided in Table II and plotted in Figure 2(a). Table III presents the
results for ANOVA. If participants incorporate the positive OCI number in their
performance evaluation, the OCI information will positively affect their judgments. To
the extent that participants paid attention to the experimental stimulus, they would
perceive higher performance in the gain condition than in the loss condition. As
expected, the participants recognized the fnancial performance in the gain condition
(mean rating ?7.78) to be signifcantly higher than in the loss condition (mean rating ?
3.67) (F(1,90) ?122.06, p ?0.01). We also predicted that in the one-statement format, the
OCI information is more likely to be assimilated into NI; thus, participants are more
likely to categorize the OCI information as a performance measure. Because the total of
Table I.
Multivariate analysis
of variance
Source Wilk’s lambda F (3.90) Signifcance
Format 0.82 4.900 0.00
Gain or loss 0.41 31.98 0.00
Format by gain or loss 0.91 2.06 0.09
Note: This table shows the results of a MANOVA with four dependent variables: fnancial
performance, degree of relatedness, weight assigned to OCI and importance of OCI; we include gender,
investment experience, work experience and the ratings on self-knowledge of OCI as covariates in our
analysis
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OCI is positive, the OCI will be perceived as a positive cue and affects participants’
evaluation positively. Thus, the assimilation process will result in higher perceived
performance in the one-statement than in the two-statement formats, regardless of proft
or loss condition. The results support this prediction as the average mean performance
rating in the one-statement condition (6.36) is signifcantly higher than in the
two-statement condition (4.98) (F(1.90) ?12.30, p ?0.01). The interaction between the
independent variables is not signifcant. Thus, the results support H1.
To provide further support to H1 we ask participants to evaluate the relatedness of
the NI and OCI. Specifcally, we asked the following question on an 11-point scale:
“Please indicate to what degree Net Income and Other Comprehensive Income are
related? (1 being not at all related, 11 being very closely related)”. The mean ratings are
provided in Table II and plotted in Figure 2(b). Table III presents the results for the
ANOVA. The results of the ANOVA show a signifcant main effect for the format
variable but not for the gain/loss variable. Participants perceive NI and OCI to be
signifcantly more related to each other in one continuous statement (average mean ?
6.13) than two separate statements (average mean ? 4.89) (F (1,90) ? 6.81, two-sided
p ?0.01) regardless of gain or loss position. No signifcant interaction is observed for the
interaction of the two independent variables. Thus, the results further support H1.
H2 predicts that participants will assign greater weight to OCI in the one-statement
format than in the two-statement format. To test this hypothesis, we asked the following
question:
In your evaluation of Company XYZ, how did you weight the two different numbers – Net
Income and Other Comprehensive Income? Please give a percentage to each number. Note that
both percentages should add up to 100 per cent.
Thus, the dependent variable is the weight assigned to OCI. Table II provides the mean
percentages of OCI weights which are plotted in Figure 2(c). The overall weight is less
than 40 per cent. This suggests that, in general, participants recognize the importance of
Table II.
Means (variances) for
dependent variables
(tests of H1 and H2)
Tests of between-subjects
effects (H1 and H2)
Gain Loss
One-statement Two-statement One-statement Two-statement
N ?25 N ?23 N ?22 N ?24
Weight assigned to OCI 34.8%(10.75) 38.96%(14.67) 37.73%(20.85) 25.31%(14.03)
Importance of OCI 7.16 (2.36) 5.70 (3.44) 6.91 (2.50) 5.88 (2.25)
Financial performance 8.04 (1.34) 7.09 (1.12) 4.45 (2.48) 2.95 (1.58)
Degree of relatedness 6.00 (2.20) 4.43 (2.27) 6.27 (2.22) 5.33 (2.57)
Notes: This table presents the means (std) for the dependent variables: rating for relatedness between
NI and OCI, percentage weight assigned to OCI, NI importance rating and rating for fnancial
performance; the dependent variables are based on the following four questions: Please indicate to what
degree net income and other comprehensive income are related?; In your evaluation of Company XYZ,
how did you weight the two different numbers – net income and other comprehensive income? Please
give a percentage about the attention you paid to each number. Note that both percentages should add
up to 100%; please rate the importance of Other Comprehensive Income when evaluating XYZ (on an
11-point scale); How strong is the fnancial performance of Company XYZ? (on an 11-point scale); the
independent variables are Format, which is manipulated at two levels: one-statement and
two-statements, and gain/loss
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NI and pay much less attention to OCI information than NI. The results of ANOVA
presented in Table III show a non-signifcant format effect, but a marginal signifcant
effect of gain or loss (F(1,90) ? 2.86, p ? 0.09). Apparently, participants value OCI
slightly higher in the gain than loss condition, as they assigned a mean rating of 36.80
per cent in the gain condition and a mean rating of 31.25 per cent in the loss condition. A
close inspection of the graph suggests that in the loss condition, the two-statement
format generates the lowest rating of 25 per cent. This suggests that participants are
reluctant to rely on the positive number of OCI when a company suffers an economic
loss. In addition, the results of ANOVA show a signifcant interaction between the two
independent variables (F (1,90) ? 6.84, p ? 0.01). Given the signifcant interaction, we
conduct pairwise comparisons across gain and loss conditions. Results of pairwise
comparisons (see Table IV) suggest that in the gain condition, participants assign
similar weights to OCI as the difference between one- and two-statement formats is not
signifcantly different (mean difference ??4.16 per cent, p ?0.05); however, in the loss
condition participants assign signifcantly higher weight in the one-statement than in
Figure 2.
Various judgments
regarding CI format
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the two-statement format (mean difference ? 12.42 per cent, p ? 0.01). Apparently,
when the company suffers economic losses, participants are more likely to rely on the
positive OCI cue if it is presented in the one-statement format. Therefore, the
one-statement format indeed increases the salience of OCI information, but only in
the loss situation. Thus, the results partially support our Hypothesis 2.
To provide further support to H2, we asked the participants to rate the importance of
OCI on an 11-point scale (1 being not important, 11 very important). The mean ratings
are provided in Table II and plotted in Figure 2(c). Table III presents the results for the
ANOVA. The overall rating for OCI’s importance is 6.41 (below 7), suggesting that
participants do not perceive OCI as an important fnancial performance measure.
Table III.
Tests of between-
subjects effects (H1
and H2)
Source df MS F p (2-sided)
Future performance
Format 1 35.16 12.30 0.00
Gain/Loss 1 348.81 122.05 0.00
Format X gain/loss 1 1.72 0.60 0.43
Within cells (error) 90 2.85
Degree of relatedness
Format 1 36.771 6.81 0.01
Gain/loss 1 8.042 1.49 0.22
Format X gain/loss 1 2.296 0.42 0.51
Within cells (error) 90 2.858
Weight assigned to OCI
Format 1 399.75 1.69 0.19
Gain/loss 1 673.20 2.86 0.09
Format X gain/loss 1 1,609.66 6.84 0.01
Within cells (error) 90 235.24
Importance of OCI
Format 1 36.59 5.12 0.02
Gain/loss 1 0.030 0.00 0.94
Format X gain/loss 1 1.08 0.15 0.69
Within cells (error) 90 7.141
Notes: H1 predicts that nonprofessional investors are more likely to judge higher fnancial
performance when positive OCI information is presented in the one-statement format than in the
two-statement format. We test this hypothesis using the following question: Howstrong is the fnancial
performance of Company XYZ? (on an 11-point scale). The independent variables are Format, which is
manipulated at two levels: one statement and two statements, and gain/loss. We also use the following
question to test H1: Please indicate to what degree net income and other comprehensive income are
related? (on an 11-point scale); H2 predicts that nonprofessional investors assign greater weight to other
comprehensive income in the one-statement format than the two-statement format. We test this by the
following question: In your evaluation of Company XYZ, how did you weight the two different
numbers – net income and other comprehensive income? Please give a percentage about the attention
you paid to each number. Note that both percentages should add up to 100%. In addition, we ask
nonprofessional investors judge OCI information more important in the one-statement format than the
two-statement format. We test H3 using this question: Please rate the importance of other
comprehensive income when evaluating XYZ (on an 11-point scale)
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Results of ANOVA show a signifcant main effect for the format variable (F (1,90) ?
5.12, p ? 0.05) but no signifcant effect for gain or loss or the interaction of the two
independent variables. Apparently, participants believe OCI to be more important in the
one-statement condition (mean ? 7.04) than in the two-statement condition (mean ?
5.78). The results support H2.
5. Conclusions
The results of the experiment suggest that participants are more likely to
incorporate OCI information in the one-statement format than in the two-statement
format and are in support of the common concern that the one-statement format may
draw the attention of fnancial statement users away from NI to OCI as the “bottom
line” of a business, especially when the company suffers economic losses. However,
this experimental investigation, like others, is limited in several respects. We
manipulated the format as one continuous statement versus two separate
statements. In the two-statement format, the NI total is carried over from the
previous page. Even though the FASB does not require the statement of CI to begin
with NI, some frms may choose to report items of NI on the second statement of CI.
Future research could test whether differences in formatting within the
two-statement format make a difference to users. In addition, we manipulate
fnancial position by varying the sign of NI but holding OCI constant as a positive
fgure. As people often react differently to gains and losses (Du, 2009), future studies
should investigate the format effects when OCI is negative. Moreover, this study
uses graduate accounting students rather than real investors. Because our
experiment requires the participants to have some, but not extensive, knowledge of
CI, we believe graduate accounting students are an appropriate proxy for
nonprofessional investors. However, we mention at this point that many accounting
and auditing studies have employed both undergraduate and graduate students
(Budescu and Du, 2007; Du, 2009; Du et al., 2011; Du and Budescu, 2005; Elliott et al.,
2007). Despite the extensive use of students in various behavioral experiments,
future studies should explore howreal market participants react to different formats
of presenting OCI information.
Table IV.
Percentage weight
assigned to other
comprehensive
income (test of H2)
(Figure 2(c): Results
of pairwise
comparisons)
Condition Comparison Mean Diff. Std. Sig. (2-sided)
Gain One vs. two-statement ?4.16 4.43 0.35
Loss One vs. two-statement 12.42 4.527 0.00
One statement Gain vs. loss ?2.93 4.48 0.52
Two statement Gain vs. loss 13.64 4.47 0.00
Notes: H2 predicts that the weight assigned to other comprehensive income will be more sensitive to
gain or loss for one-statement than two-statement condition. To test this hypothesis, we asked the
following question: In your evaluation of Company XYZ, how did you weight the two different
numbers – net income and other comprehensive income? Please give a percentage about the attention
you paid to each number. Note that both percentages should add up to 100%. The dependent variable
is weight assigned to other comprehensive income. The independent variables are Format, which is
manipulated at two levels: one statement and two statements, and gain/loss
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Further reading
American Accounting Association’s Financial Accounting Standards Committee (FASC) (1997),
“An issues paper on comprehensive income”, Accounting Horizons, Vol. 11 No. 2,
pp. 120-126.
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PWC Dataline (2012), “A look at current fnancial reporting issues”, available at: www.pwc.com/
en_US/us/cfodirect/assets/pdf/dataline-2012-01.pdf
Corresponding author
Ning Du can be contacted at: [email protected]
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doc_960655453.pdf
This paper aims to understand the effects of different presentation formats on
nonprofessional investors’ judgments. Both International Financial Reporting Standards and US
Generally Accepted Accounting Principles require an entity to present items of net income and other
comprehensive income (OCI) either in one continuous or in two separate, but consecutive, statements
but limited understanding exists about their differential effects on evaluation of company performance.
Accounting Research Journal
The effects of comprehensive income on investors’ judgments: An investigation of
one-statement vs. two-statement presentation formats
Ning Du Kevin Stevens J ohn McEnroe
Article information:
To cite this document:
Ning Du Kevin Stevens J ohn McEnroe , (2015),"The effects of comprehensive income on investors’
judgments", Accounting Research J ournal, Vol. 28 Iss 3 pp. 284 - 299
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The effects of comprehensive
income on investors’ judgments
An investigation of one-statement vs.
two-statement presentation formats
Ning Du, Kevin Stevens and John McEnroe
School of Accountancy and MIS, DePaul University, Chicago, Illinois, USA
Abstract
Purpose – This paper aims to understand the effects of different presentation formats on
nonprofessional investors’ judgments. Both International Financial Reporting Standards and US
Generally Accepted Accounting Principles require an entity to present items of net income and other
comprehensive income (OCI) either in one continuous or in two separate, but consecutive, statements
but limited understanding exists about their differential effects on evaluation of company performance.
Design/methodology/approach – To investigate this research question, we used a two (Financial
Position) x two (Format) randomized between-subjects experiment. Ninety-four graduate students
assumed the role of investor and participated in this study.
Findings – Results of the experiment suggest that participants are more likely to incorporate OCI
information presented in the one-statement format than in the two-statement format. Further analysis
suggests that participants both assign more weight to OCI and perceive OCI to be relatively more
important in the one-statement format than in the two-statement format, especially when the entity
suffers an economic loss.
Originality/value – Results fromthis study provide evidence to the Financial Accounting Standards
Board and International Accounting Standards Board that should be useful in evaluating the
effectiveness of alternative comprehensive income reporting formats and should be of interest to
accounting rule-making bodies, investors, publicly traded entities and fnancial analysts, among others.
Keywords Judgment, Assimilation, Net income, Other comprehensive income,
Nonprofessional investors
Paper type Research paper
1. Introduction
Both the International Accounting Standards Board (IASB) and the Financial
Accounting Standards Board (FASB) currently require frms to disclose other
comprehensive income (OCI) in a performance-based reporting option and allow the
choice of reporting OCI either in one continuous statement (i.e. the statement of
comprehensive income) or in two separate, but consecutive, statements. US Generally
Accepted Accounting Principles (US GAAP) has historically allowed comprehensive
income (CI) to be reported in a nonperformance-based statement such as stockholders’
equity. Given the ample evidence suggesting that managers strategically choose the
equity format option for self-serving reasons (Bamber et al., 2010; Hunton et al., 2006; Lee
et al., 2006), it is not surprising that, in June 2011, the US FASB eliminated that format
and achieved convergence of guidance on the CI presentation between US GAAP (see
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1030-9616.htm
ARJ
28,3
284
Received15 November 2013
Revised14 May2014
11 August 2014
Accepted21 August 2014
Accounting Research Journal
Vol. 28 No. 3, 2015
pp. 284-299
©Emerald Group Publishing Limited
1030-9616
DOI 10.1108/ARJ-11-2013-0083
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Accounting Standard Codifcation (ASC) Topic 220) and International Financial
Reporting Standards (IFRS; see IAS 1, 2010, Presentation of Financial Statements).
Prior research on OCI mostly examines the difference between a performance-based
statement (e.g. the two-statement option) and a nonperformance-based statement (i.e.
owner’s equity). This study focuses on the performance-based option and examines the
difference between the one-statement and two-statement formats. In spite of reporting
the same total OCI number, these two formats present the OCI information in different
locations. Unlike the one-statement format, which combines net income (NI) and
components of OCI in one continuous statement, the two-statement approach, by
leaving the income statement in its current form, adds a second statement which reports
the components of OCI. Because the one-statement format tends to bury NI within CI (i.e.
a subtotal in the middle of a continuous statement of CI), many have criticized the
one-statement approach for awarding NI and OCI the same prominence in the income
statement in spite of their conceptual differences. Therefore, we want to understand
whether, compared to the two-statement approach, the one-statement presentation of
OCI may increase the salience of OCI while diminishing the importance of NI. In other
words, will the one-statement format, by presenting the NI and OCI in close proximity,
draw investors’ attention away from NI as the “bottom line” of a business and affect
nonprofessional investors’ evaluation of a company’s fnancial performance?
OCI is conceptually different from NI; NI summarizes the current fnancial
performance results of operating a company and is a clear indicator of current fnancial
performance, but OCI presents information about a company’s potential income and
cash fows fromtransactions generally to be fnalized sometime in the future. Because of
its complexity, determining how to use and/or how much to use the OCI information is
not an easy task, especially for nonprofessional investors. As argued by Maines and
McDaniel (2000), because nonprofessional investors are limited in their understanding
of fnancial analysis, the format of the fnancial statement is important in that it provides
signals about the nature and importance of CI information (Maines and McDaniel, 2000,
p. 10). Thus, the location of OCI becomes an important cue for assessing the importance
of OCI information when investors evaluate a company’s fnancial performance.
Based on the inclusion-exclusion model in the psychology literature (Schwarz and
Bless, 1992), we argue that investors are more likely to incorporate OCI in their
evaluations of fnancial performance when OCI is represented in the one-statement, than
the two-statement, format. To test these hypotheses, we use a two (fnancial position) x
two (format) randomized between-subjects experiment. We manipulate fnancial
position as gain or loss of CI, and we manipulate format as one (continuous) statement or
two (separate) statements. Ninety-four graduate students assumed the role of investors
and participated in this study. Results of the experiment suggest that higher perceived
fnancial performance is related to the one-statement format, potentially because of the
close proximity of OCI and NI, which may have led to a higher assigned weight to OCI
in the performance evaluation. This effect is particularly strong when the company
suffers a fnancial loss.
This study contributes to the prior literature in several ways. First, this investigation
extends prior research on the reporting format of CI. Unlike prior studies, which tend to
focus on comparing the performance option and the nonperformance option, we
investigate the subtle differences between performance-based options. Our results
suggest that despite both being performance-based, the two currently allowed OCI
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presentation formats may lead to different judgments among nonprofessional investors.
In addition, we fnd that the format effect is quite complex: though investors may prefer
the clarity of one continuous statement, the one-statement reporting format may dilute
the focus on NI as the most important performance measure of a company. Moreover,
this study extends Maines and McDaniel (2000) by providing evidence about how the
location of OCI information affects nonprofessional investors’ differential weighting of
OCI information across the different performance-based statement. Lastly, the results
fromthis study are timely and provide evidence to the FASBand IASBin evaluating the
effectiveness of alternative CI reporting formats and should be of interest to accounting
rule-making bodies, investors, publicly traded entities and fnancial analysts, among
others.
2. Literature review and hypothesis development
2.1 History of CI
Prior to 1997, OCI was not required to be reported anywhere in the fnancial statements,
and many of its components bypassed the income statement and went directly to
owners’ equity. In 1997, the FASB issued SFAS 130 (ASC Topic 220), Reporting
Comprehensive Income (FASB, 1997), requiring companies to report and display CI and
its components in a primary fnancial statement. FAS 130 (ASC Topic 220) defnes CI as
consisting of NI and OCI. Other Comprehensive Income refers to revenues, expenses,
gains and losses that under US GAAP are included in CI but excluded from NI (i.e.
unrealized holding gains and losses on available for-sale securities, additional minimum
pension liability adjustments, currency translations, gains and losses of cash fow
hedges and asset revaluations). In 2007, the IASBpublished a revised version of the IAS
1 – Presentation of Financial Statements to bring OCI into line with the reporting
requirement of SFAS 130. Figure 1 presents a diagramillustrating the timeline of events
regarding OIC formats.
CI is derived fromthe concept of an all-inclusive income statement which refers to all
the changes in assets and liabilities other than those that involve transactions with
owners. It satisfes the desire of fnancial statement users for one fgure, which includes
all components of income that lead to changes in the overall fnancial position of
organizations. Statement of Financial Accounting Concepts No. 6 (SFAC 6, 1985),
Elements of Financial Statements, defnes CI as:
[…] the change in equity 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 distribution to owners.
The concept of CI is closely related to the “clean” vs “dirty” surplus concept. Under the
clean surplus approach, all income items must pass through the income statement; they
sometimes are referred to as items that are reported above the line (the NI line). Thus,
earned surplus (equivalent to retained earnings) was “clean” of these items (Lee et al.,
2006). Under the dirty surplus approach, certain items bypass the income statement and
are directly reported in the statement of owners’ equity. These items were given the
name “Other Comprehensive Income (OCI)”. Accordingly, the notion of dirty surplus
includes items that are reported below the NI line.
The lack of a conceptual defnition of the difference between NI items and OCI items
creates the OCI controversy. Most transactions recorded in OCI refect changes in the
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fair value of various assets and consist mostly of unrealized gains or losses driven by
external market factors. Thus, CI measures cash fow plus changes in net asset value.
Even though future income and cash fows are valuable information, nonprofessional
investors may not understand the nature of OCI and may have diffculty in viewing it as
a reliable performance measure. Recent standards, such as those on fnancial
instruments and post-employment benefts, increase the prominence of fair value as the
primary measurement attribute and thus expand the use of OCI. For example, requiring
companies to record changes in fair value for many fnancial instruments (including
most loans and issued debt) through OCI magnifes the difference between NI and OCI
in the fnancial statements. However, the more important conceptual issues such as
whether OCI is a performance measure, and concomitantly, what the items included in
OCI are intended to represent (i.e. whether they fulfll the criteria of income or expense
or, rather, represent other non-owner changes in equity) remain problematic and
controversial. Not surprisingly, the lack of a clear conceptual defnition of what should
be reported in NI and what should be reported in OCI complicates the decision processes
of fnancial statement users. For example, despite recent convergence efforts, the FASB
and the IASB differ sharply in reclassifying (recycling) OCI items into NI. Under US
GAAP, amounts initially recognized in OCI are reclassifed eventually into proft or loss,
In 1997, the FASB issued
SFAS 130 (ASC Topic
220), requiring OCI to be
reported in one-statement,
two-statement or the
owners’ equity format.
In 2007, the IASB
published revised
IAS 1—
Presentation of
Financial
Statements,
requiring OCI to
be reported in
one- statement or
two-statement
In 2011, the FASB issued
ASU No. 2011-05 to
amend SFAS 130 (ASC
220), eliminating the
equity option for CI
reporting and requiring
OCI to be reported in one-
statement or two-
statement
Figure 1.
Timeline of events
regarding OCI
reporting
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whereas under IFRS different items are reclassifed in different ways (e.g. actuarial
gains and losses related to employee beneft plans recognized initially in OCI are not
reclassifed into proft or loss).
2.2 OCI reporting formats
The presentation of CI has always been controversial. In 1997, the FASB issued SFAS
130 (ASC Topic 220) which specifed three options for reporting CI: one-statement,
two-statement or the equity format. The one-statement (combined statement of income
and CI) format displays the components of OCI belowthe NI total in a traditional income
statement. The two-statement approach presents each component of OCI in a separate
statement of CI that begins with NI. Both formats end with the same total CI. The equity
format, the most popular approach among corporate managers, reports CI as part of the
statement of changes in stockholders’ equity. While all three options were acceptable,
the FASB encouraged reporting OCI in the performance-based statement employing
either the one- or two-statement format and discouraged the use of the equity format
because, as the FASB concludes, the equity format lacks transparency by “hiding” CI in
a nonperformance-based statement. However, the IASBdid not give companies as much
discretion as the FASB. In the revised IAS 1 (2007), IASB only allows the use of
performance-based reporting format to report OCI, i.e. the one-statement or
two-statement presentation but does not permit the equity option. On June 16, 2011, the
FASB (2011) issued Accounting Standards Update No. 2011-05, Presentation of
Comprehensive Income to amend ASC Topic 220, Comprehensive Income. This standard
eliminates the option to present items of OCI in the statement of changes in stockholders’
equity, but allows the choice of presenting items of NI and OCI either in one continuous
statement (i.e. the statement of CI) or in two separate, but consecutive, statements.
2.3 Prior academic research on OCI
Accounting researchers have been interested in understanding the effects of CI and its
presentation on users of fnancial statements. Prior archival researchers have examined
company’s actual choices in selecting CI reporting formats. Jordan and Clark (2002) and
Pandit and Phillips (2004) fnd the majority (more than 60 per cent) of the companies
used the equity option, followed by the one-statement format and then fnally, the
two-statement format. In addition, their evidence shows that companies with negative
OCI were more likely to adopt the equity option, implying that managers choose a
nonperformance-based fnancial statement such as stockholders’ equity to “bury” the
loss in equity rather than having the loss prominently displayed in the income
statements.
Another streamof archival research focuses on the effects of presentation formats of
OCI information on the entity’s market return; however, the results are inconclusive. For
example, some studies fnd that CI is more relevant than NI as a performance indicator
because of its stronger correlation to stock return than NI (Biddle and Choi, 2006; Cahan
et al., 2000; Chambers et al., 2007). In contrast, Dhaliwal et al. (1999) documented no
evidence of a strong association between CI and US stock market returns. In a more
recent study, Bamber et al. (2010) investigated a broad cross-section of frms and fnd
that over 80 per cent of their sample S&P 500 frms report CI in the statement of equity.
They conclude, managers with stronger equity-based incentives and less job security
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are concerned about volatility in CI when it is reported in the income statement, and,
thus, prefer the equity option.
Behavioral researchers focus on the differential effects of reporting formats on the
judgments of fnancial statement users such as analysts and individual investors.
Hunton et al. (2006) examine whether the display of CI affects managers’ selective sale of
available-for-sale (AFS) securities to manage earnings. In their study, fnancial
executive participants prefer the less transparent equity format for earnings
management (EM), but when the authors require participants to report total CI in a
single continuous statement, participants are reluctant to engage in EMattempts. With
a focus on fnancial analysts’ stock valuations, Hirst and Hopkins (1998) compare the
equity to the two-statement approach. They fnd that analysts fail to identify unrealized
gain and loss (UGL) information for AFS when this information is presented in a
statement of stockholders’ equity, but that the reporting of UGL in a separate
two-statement of CI enhances fnancial analysts’ ability to detect EM through selective
sale of AFS.
Maines and McDaniel (2000) argue that the reporting format of CI is unlikely to affect
the judgments of more sophisticated market participants, such as fnancial analysts,
because analysts understand the role of CI in frm evaluation and will conduct an
extensive search for this information (Hunton and McEwen, 1997). In contrast, Maines
and McDaniel (2000) investigate nonprofessional investors’ responses to different CI
reporting formats. Ninety-fve MBA students participated in their study and analyzed
an insurance company’s fnancial statements which included low and high volatility
produced by unrealized gains of AFS market securities. They fnd that participants are
sensitive to the negative effects of volatility on corporate and management performance
and placed signifcant weight on volatility when OCI is presented in a separate
two-statement format but not when it is in an equity format. They conclude that
the reporting format has no effect on investors’ acquisition and evaluation of OCI
information but does have an effect on the weighting of OCI information. In summary,
prior studies focus on the equity option, but none of the above studies investigates the
differences between the one-statement and two-statement formats.
2.4 Hypotheses development
In both one-statement and two-statement formats, the NI and OCI are shown together as
components of CI, included in the same CI category, and summed with the total
presented; however, the two formats differ signifcantly in where the information is
presented. Specifcally, the one-statement format presents the breakdown of OCI
directly after the NI number, and both NI and OCI information is often presented on the
same page and appears in a continuous statement. In contrast, in the two-statement
format, the NI statement and the statement of CI (the second statement) are often
presented on different, separate pages. In a recent study, Hodge et al. (2010) examine
fnancial statement format effects with a focus on information proximity. Guided by the
proximity compatibility principle, they predict users will more effective and effciently
integrate fnancial information that is presented in close proximity such as on a single
statement (or page) rather than on separate statements (Wickens and Carswell, 1995;
Carswell and Wickens, 1996). In their study, they presented fnancial information such
as cash fow and non-cash assets to graduate accounting students, and found that
presenting information on a single page results in reduced forecast errors and faster
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learning in forecasting future cash fow. Results fromHodge et al. (2010) suggest that the
choice of reporting OCI in the one-statement versus the two-statement format will affect
investors’ judgments because these two formats differ in their information proximity.
The effects of information proximity can be explained by the Inclusion-Exclusion
Model proposed by Schwarz and Bless (1992 and 2007). That is, the way a piece of
information infuences judgments depends on how it is categorized. The
Inclusion-Exclusion Model holds that assimilation effects result when the stimulus
information is included in the temporary representation that individuals form of the
target category; thus, judgment refects the information that is included in the
representation used. For example, the addition of some positive information results in a
more positive judgment, whereas the addition of some negative information results in a
more negative judgment. Because individuals do not retrieve or use all knowledge, but,
rather, rely on the subset of potentially relevant information that is most accessible at
the time of judgment, the categorization of information is susceptible to contextual
infuences. One such infuence is the boundary of information. The inclusion-exclusion
model argues that fuzzier boundaries of stimulus and target, or a shorter distance
between these two, would promote assimilation because closeness implies that both
stimulus and target belong to the same category, and, therefore, increases the likelihood
of inclusion, whereas stronger boundaries and greater distance would lead to the
opposite effect. Evidence from prior accounting research also supports the linkage
between fexible categorization and fuid information assimilation. For example, Lipe
and Salterio (2000) document that direct links between information items help
decision-makers mentally “chunk” these items, thereby increasing the weight placed on
the items in forming judgments. Hopkins (1996) documents that fnancial analysts use
accounting classifcation to interpret information. In particular, his evidence suggests
that whether hybrid fnancial instruments are categorized as a liability or owners’
equity affects fnancial analysts’ common stock valuations.
Similarly, we argue that the placement and location of OCI affects how investors
categorize OCI information, in other words, whether or not they classify OCI in the
category of a performance measure. We propose that OCI is more likely to be assimilated
into the category of performance measure in the one-statement format because of its
close proximity to NI. Investors are familiar with the traditional income statement
format. When OCI is added directly below the NI in a traditional income statement,
investors are more likely to viewOCI to be a similar measure as NI and, thus, categorize
OCI as a performance indicator. On the contrary, when OCI is included in a separate
statement, investors may have diffculty in classifying the nature of the indicator and
will not be sure whether it indeed belongs to the traditional income statement. Thus, OCI
in the two-statement format is less likely to be viewed as a similar measure to NI and,
therefore, will be less likely to be judged as performance related. Assuming a company
has positive OCI because of unrealized gains, if OCI is viewed as a performance measure,
the OCI will cast a more positive light on the company’s operations regardless of their
profts or losses in operating income. Therefore, our Hypothesis 1 focuses on the impact
of positive OCI information on investors’ evaluation of fnancial performance:
H1. Nonprofessional investors are more likely to judge that a company has higher
fnancial performance when positive OCI information is presented in the
one-statement format than in the two-statement format.
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Nonprofessional investors have relatively ill-defned valuation models (Maines and
McDaniel, 2000); thus, most of themlack a clear understanding of the difference between
NI items and OCI items and are not sure to what extent to rely on OCI in their
performance evaluation. In their study, they fnd that alternative OCI presentation
formats affect nonprofessional investors’ weighting of volatility information. Similarly,
we argue that when individuals form a judgment about operating results based on NI,
they construct a mental representation of corporate performance; the close association
between OCI and NI implies that both items belong to the same category which, in turn,
increases the likelihood of including OCI in a mental representation of the performance
judgment. Thus, the second hypothesis focuses on the weight assigned to OCI by
investors across different formats:
H2. Nonprofessional investors assign greater weight to OCI in the one-statement
format than in the two-statement format.
3. Method
3.1 Participants
The participants are 94 graduate students from a large private university in the USA.
These students are currently enrolled in the master of accounting program. We recruited
the students in their intermediate accounting course. Students volunteered to participate
in response to in-class announcements for extra course credit. Demographic information
collected at the end of the experiment indicates that most participants are likely to have
the necessary knowledge and experience to complete the task. For example, the majority
of participants have both work and investment experience. On average, participants
have about 1.83 years of working experience and 1.07 years of investment experience.
We also ask themto indicate howmuch knowledge they have about CI. The mean rating
is 5.52 on an 11-point scale (1 being very little, 11 being a great deal). The rating of 5.52
suggests that participants are not confdent about their understanding of OCI, a result
we surmise refects the general competence of individual nonprofessional investors.
Among the participants, 24 are males and 70 are females, representative of the graduate
school cohort. Despite the difference in gender numbers, we do not perceive this to affect
the results of our study (a MACOVA analysis indicates that the gender factor is not
signifcant).
3.2 Procedure and task
In the experiment, we asked the participants to assume the role of investor. Their task
was to evaluate the provided fnancial statements and assess the fnancial performance
of XYZ Company. The fnancial statements included NI and CI information, and were
constructed from OCI examples in PWC Dataline (www.pwc.com). In addition, the
instruction provides a short explanation about the difference between CI and NI by
including the following paragraph:
Comprehensive income includes both Net Income and Other Comprehensive Income. Net
income summarizes the current fnancial results of operating a company and refects complete
transactions (or nearly complete) that produce currently available net earnings and cash fows
for use by a company’s management. However, most transactions recorded in Other
Comprehensive Income refect changes in fair value and consist of unrealized gains or losses
driven by external market factors. Other Comprehensive Income consists of long-termand less
recurring items and may or may not affect future cash fows of an entity. In other words, Other
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Comprehensive Income eventually may or may not be realized as Net Income in the future.
Unlike the Statement of Net Income, the Statement of Comprehensive Income includes both net
income and other comprehensive income.
After reviewing the provided information, participants made a series of judgments
about Company XYZ. Finally, participants fnished by answering a short series of
manipulation check questions and were debriefed. The entire experiment took 20
minutes on average to complete.
3.3 Independent variables
We use a two (fnancial position) x two (format) between-subjects design. The fnancial
position variable is manipulated at two levels (gain or loss) and the format variable at
two levels (one-statement or two-statement). Participants are randomly assigned to
experimental conditions. We manipulate fnancial position as gain or loss of CI. The loss
condition is included for two reasons:
(1) to ensure that the predicted effects are consistent across profts and losses; and
(2) to ensure participants attend to the experimental stimulus and the differential
between gains and losses.
We achieve this by holding OCI constant at $840,000 but varying proft or loss in the
income statement. Both conditions have the same revenue of $3,550,000. We create a
mirror image of proft or loss by varying the expense section, with a NI of $1,400,000 for
the gain condition and a net loss of $1,400,000 in the loss condition. Thus, we have a CI
of $2,240,000 in the gain condition and $560,000 in the loss condition.
We manipulate the format variable as one continuous statement or two separate
statements. In the one-statement condition, OCI follows directly after NI and earnings
per share. The heading reads as “Statement of Comprehensive Income (XYZ Inc.) for
Year ended December 31, 2011”. All information is presented on one single page. The
two-statement condition contains two separate pages. The frst page includes
“Statement of Net Income for Year ended December 31, 2011”. The second page includes
“Statement of Comprehensive Income for Year ended December 31, 2011”, which starts
with NI, followed directly by OCI. In both formats, the total of CI is presented at the end
of the statements.
3.4 Dependent variables
Dependent variables include the strength of fnancial performance and percentage
weight assigned to OCI. We also collected judgments on the degree of relatedness
between NI and OCI and the importance of OCI.
4. Results
4.1 Manipulation checks
To check the fnancial position and format manipulation, we ask participants to
examine the received information and list the amounts of NI or loss, OCI or loss and total
CI or loss for XYZ Inc. All participants identifed the right amounts in their assigned
conditions.
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4.2 Multivariate analysis of covariance
As the four dependent variables are potentially correlated, we rely on multivariate
analysis of covariance (MACOVA) for the initial analysis. First, we examine the
assumption of equality of covariance matrices across treatment groups. The Box
statistic is signifcant with a Box’s M of 73.72 (F ?2.26, p ?0.05). However, we are not
concerned with violations of the equality assumption, because of our approximately
equal group sizes (Hair et al., 1998, p. 348). Thus, we proceed to the MACOVA analysis.
To control for any potentially extraneous infuence on dependent variables, we include
gender, investment experience, work experience and the ratings on self-knowledge of
OCI as covariates in our analysis. The results of MACOVAare presented in Table I and
show that both independent factors are signifcant. Wilks’ lambdas are 0.82 (F ?4.90,
p ? 0.01) for format and 0.41for gains or loss (F ? p ? 0.01). Their interaction are
marginally signifcant (Wilks’ lambda ? 0.91, F ? 2.06, p ? 0.09). In addition,
MACOVA indicates none of the four control variables is signifcant. Specifcally, for
self-knowledge, Wilks’ lambda is 0.95 (F ?2.85, p ?0.05); for work experience, Wilks’
lambda is 0.94 (F ? 2.64, p ? 0.05); for investment experience, Wilks’ lambda is 0.96
(F?1.63, p ?0.05); for gender, Wilks’ lambda is 0.95 (F?1.92, p ?0.05). Because of the
signifcant results of our independent variables, we follow up with analysis of variance
(ANOVA) for each of the dependent variables.
4.3 ANOVA
H1 predicts that nonprofessional investors are more likely to judge higher fnancial
performance when positive OCI information is presented in the one-statement format
than in the two-statement format. To test this hypothesis, we asked participants to
answer the question on an 11-point scale (1 being very weak, 11 being very strong):
“How strong is the company’s fnancial performance?” The mean ratings for fnancial
performance are provided in Table II and plotted in Figure 2(a). Table III presents the
results for ANOVA. If participants incorporate the positive OCI number in their
performance evaluation, the OCI information will positively affect their judgments. To
the extent that participants paid attention to the experimental stimulus, they would
perceive higher performance in the gain condition than in the loss condition. As
expected, the participants recognized the fnancial performance in the gain condition
(mean rating ?7.78) to be signifcantly higher than in the loss condition (mean rating ?
3.67) (F(1,90) ?122.06, p ?0.01). We also predicted that in the one-statement format, the
OCI information is more likely to be assimilated into NI; thus, participants are more
likely to categorize the OCI information as a performance measure. Because the total of
Table I.
Multivariate analysis
of variance
Source Wilk’s lambda F (3.90) Signifcance
Format 0.82 4.900 0.00
Gain or loss 0.41 31.98 0.00
Format by gain or loss 0.91 2.06 0.09
Note: This table shows the results of a MANOVA with four dependent variables: fnancial
performance, degree of relatedness, weight assigned to OCI and importance of OCI; we include gender,
investment experience, work experience and the ratings on self-knowledge of OCI as covariates in our
analysis
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OCI is positive, the OCI will be perceived as a positive cue and affects participants’
evaluation positively. Thus, the assimilation process will result in higher perceived
performance in the one-statement than in the two-statement formats, regardless of proft
or loss condition. The results support this prediction as the average mean performance
rating in the one-statement condition (6.36) is signifcantly higher than in the
two-statement condition (4.98) (F(1.90) ?12.30, p ?0.01). The interaction between the
independent variables is not signifcant. Thus, the results support H1.
To provide further support to H1 we ask participants to evaluate the relatedness of
the NI and OCI. Specifcally, we asked the following question on an 11-point scale:
“Please indicate to what degree Net Income and Other Comprehensive Income are
related? (1 being not at all related, 11 being very closely related)”. The mean ratings are
provided in Table II and plotted in Figure 2(b). Table III presents the results for the
ANOVA. The results of the ANOVA show a signifcant main effect for the format
variable but not for the gain/loss variable. Participants perceive NI and OCI to be
signifcantly more related to each other in one continuous statement (average mean ?
6.13) than two separate statements (average mean ? 4.89) (F (1,90) ? 6.81, two-sided
p ?0.01) regardless of gain or loss position. No signifcant interaction is observed for the
interaction of the two independent variables. Thus, the results further support H1.
H2 predicts that participants will assign greater weight to OCI in the one-statement
format than in the two-statement format. To test this hypothesis, we asked the following
question:
In your evaluation of Company XYZ, how did you weight the two different numbers – Net
Income and Other Comprehensive Income? Please give a percentage to each number. Note that
both percentages should add up to 100 per cent.
Thus, the dependent variable is the weight assigned to OCI. Table II provides the mean
percentages of OCI weights which are plotted in Figure 2(c). The overall weight is less
than 40 per cent. This suggests that, in general, participants recognize the importance of
Table II.
Means (variances) for
dependent variables
(tests of H1 and H2)
Tests of between-subjects
effects (H1 and H2)
Gain Loss
One-statement Two-statement One-statement Two-statement
N ?25 N ?23 N ?22 N ?24
Weight assigned to OCI 34.8%(10.75) 38.96%(14.67) 37.73%(20.85) 25.31%(14.03)
Importance of OCI 7.16 (2.36) 5.70 (3.44) 6.91 (2.50) 5.88 (2.25)
Financial performance 8.04 (1.34) 7.09 (1.12) 4.45 (2.48) 2.95 (1.58)
Degree of relatedness 6.00 (2.20) 4.43 (2.27) 6.27 (2.22) 5.33 (2.57)
Notes: This table presents the means (std) for the dependent variables: rating for relatedness between
NI and OCI, percentage weight assigned to OCI, NI importance rating and rating for fnancial
performance; the dependent variables are based on the following four questions: Please indicate to what
degree net income and other comprehensive income are related?; In your evaluation of Company XYZ,
how did you weight the two different numbers – net income and other comprehensive income? Please
give a percentage about the attention you paid to each number. Note that both percentages should add
up to 100%; please rate the importance of Other Comprehensive Income when evaluating XYZ (on an
11-point scale); How strong is the fnancial performance of Company XYZ? (on an 11-point scale); the
independent variables are Format, which is manipulated at two levels: one-statement and
two-statements, and gain/loss
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NI and pay much less attention to OCI information than NI. The results of ANOVA
presented in Table III show a non-signifcant format effect, but a marginal signifcant
effect of gain or loss (F(1,90) ? 2.86, p ? 0.09). Apparently, participants value OCI
slightly higher in the gain than loss condition, as they assigned a mean rating of 36.80
per cent in the gain condition and a mean rating of 31.25 per cent in the loss condition. A
close inspection of the graph suggests that in the loss condition, the two-statement
format generates the lowest rating of 25 per cent. This suggests that participants are
reluctant to rely on the positive number of OCI when a company suffers an economic
loss. In addition, the results of ANOVA show a signifcant interaction between the two
independent variables (F (1,90) ? 6.84, p ? 0.01). Given the signifcant interaction, we
conduct pairwise comparisons across gain and loss conditions. Results of pairwise
comparisons (see Table IV) suggest that in the gain condition, participants assign
similar weights to OCI as the difference between one- and two-statement formats is not
signifcantly different (mean difference ??4.16 per cent, p ?0.05); however, in the loss
condition participants assign signifcantly higher weight in the one-statement than in
Figure 2.
Various judgments
regarding CI format
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the two-statement format (mean difference ? 12.42 per cent, p ? 0.01). Apparently,
when the company suffers economic losses, participants are more likely to rely on the
positive OCI cue if it is presented in the one-statement format. Therefore, the
one-statement format indeed increases the salience of OCI information, but only in
the loss situation. Thus, the results partially support our Hypothesis 2.
To provide further support to H2, we asked the participants to rate the importance of
OCI on an 11-point scale (1 being not important, 11 very important). The mean ratings
are provided in Table II and plotted in Figure 2(c). Table III presents the results for the
ANOVA. The overall rating for OCI’s importance is 6.41 (below 7), suggesting that
participants do not perceive OCI as an important fnancial performance measure.
Table III.
Tests of between-
subjects effects (H1
and H2)
Source df MS F p (2-sided)
Future performance
Format 1 35.16 12.30 0.00
Gain/Loss 1 348.81 122.05 0.00
Format X gain/loss 1 1.72 0.60 0.43
Within cells (error) 90 2.85
Degree of relatedness
Format 1 36.771 6.81 0.01
Gain/loss 1 8.042 1.49 0.22
Format X gain/loss 1 2.296 0.42 0.51
Within cells (error) 90 2.858
Weight assigned to OCI
Format 1 399.75 1.69 0.19
Gain/loss 1 673.20 2.86 0.09
Format X gain/loss 1 1,609.66 6.84 0.01
Within cells (error) 90 235.24
Importance of OCI
Format 1 36.59 5.12 0.02
Gain/loss 1 0.030 0.00 0.94
Format X gain/loss 1 1.08 0.15 0.69
Within cells (error) 90 7.141
Notes: H1 predicts that nonprofessional investors are more likely to judge higher fnancial
performance when positive OCI information is presented in the one-statement format than in the
two-statement format. We test this hypothesis using the following question: Howstrong is the fnancial
performance of Company XYZ? (on an 11-point scale). The independent variables are Format, which is
manipulated at two levels: one statement and two statements, and gain/loss. We also use the following
question to test H1: Please indicate to what degree net income and other comprehensive income are
related? (on an 11-point scale); H2 predicts that nonprofessional investors assign greater weight to other
comprehensive income in the one-statement format than the two-statement format. We test this by the
following question: In your evaluation of Company XYZ, how did you weight the two different
numbers – net income and other comprehensive income? Please give a percentage about the attention
you paid to each number. Note that both percentages should add up to 100%. In addition, we ask
nonprofessional investors judge OCI information more important in the one-statement format than the
two-statement format. We test H3 using this question: Please rate the importance of other
comprehensive income when evaluating XYZ (on an 11-point scale)
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Results of ANOVA show a signifcant main effect for the format variable (F (1,90) ?
5.12, p ? 0.05) but no signifcant effect for gain or loss or the interaction of the two
independent variables. Apparently, participants believe OCI to be more important in the
one-statement condition (mean ? 7.04) than in the two-statement condition (mean ?
5.78). The results support H2.
5. Conclusions
The results of the experiment suggest that participants are more likely to
incorporate OCI information in the one-statement format than in the two-statement
format and are in support of the common concern that the one-statement format may
draw the attention of fnancial statement users away from NI to OCI as the “bottom
line” of a business, especially when the company suffers economic losses. However,
this experimental investigation, like others, is limited in several respects. We
manipulated the format as one continuous statement versus two separate
statements. In the two-statement format, the NI total is carried over from the
previous page. Even though the FASB does not require the statement of CI to begin
with NI, some frms may choose to report items of NI on the second statement of CI.
Future research could test whether differences in formatting within the
two-statement format make a difference to users. In addition, we manipulate
fnancial position by varying the sign of NI but holding OCI constant as a positive
fgure. As people often react differently to gains and losses (Du, 2009), future studies
should investigate the format effects when OCI is negative. Moreover, this study
uses graduate accounting students rather than real investors. Because our
experiment requires the participants to have some, but not extensive, knowledge of
CI, we believe graduate accounting students are an appropriate proxy for
nonprofessional investors. However, we mention at this point that many accounting
and auditing studies have employed both undergraduate and graduate students
(Budescu and Du, 2007; Du, 2009; Du et al., 2011; Du and Budescu, 2005; Elliott et al.,
2007). Despite the extensive use of students in various behavioral experiments,
future studies should explore howreal market participants react to different formats
of presenting OCI information.
Table IV.
Percentage weight
assigned to other
comprehensive
income (test of H2)
(Figure 2(c): Results
of pairwise
comparisons)
Condition Comparison Mean Diff. Std. Sig. (2-sided)
Gain One vs. two-statement ?4.16 4.43 0.35
Loss One vs. two-statement 12.42 4.527 0.00
One statement Gain vs. loss ?2.93 4.48 0.52
Two statement Gain vs. loss 13.64 4.47 0.00
Notes: H2 predicts that the weight assigned to other comprehensive income will be more sensitive to
gain or loss for one-statement than two-statement condition. To test this hypothesis, we asked the
following question: In your evaluation of Company XYZ, how did you weight the two different
numbers – net income and other comprehensive income? Please give a percentage about the attention
you paid to each number. Note that both percentages should add up to 100%. The dependent variable
is weight assigned to other comprehensive income. The independent variables are Format, which is
manipulated at two levels: one statement and two statements, and gain/loss
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Stapel, D.A. and Suls, J. (Eds), Assimilation and Contrast in Social Psychology, Psychology
Press, Philadelphia, pp. 119-142.
Wickens, C.D. and Carswell, C.M. (1995), “The proximity compatibility principle: its psychological
foundation and relevance to display design”, Human Factors, Vol. 37 No. 3, pp. 473-494.
Further reading
American Accounting Association’s Financial Accounting Standards Committee (FASC) (1997),
“An issues paper on comprehensive income”, Accounting Horizons, Vol. 11 No. 2,
pp. 120-126.
International Accounting Standards Board (IASB) (2010), Presentation of Items of Financial
Statements (IAS 1), IASB, London.
PWC Dataline (2012), “A look at current fnancial reporting issues”, available at: www.pwc.com/
en_US/us/cfodirect/assets/pdf/dataline-2012-01.pdf
Corresponding author
Ning Du can be contacted at: [email protected]
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