Prior to the introduction of IFRS 9, OCI had 5 components and the easier way to remember was the acronym CAART – which is:
- C – The effective portion of gains/losses on hedging instruments in a Cash flow hedge
- A - Actuarial gains and losses on defined benefit pension plans
- A - Gains and losses on Available-for-sale financial assets
- R - Revaluation surplus related to property, plant and equipment
- T - Gains and losses arising from Translating the financial statements of a foreign operation
Now with IFRS 9 earlier adoption, the acronym has changed from CAART to CRAAFT
- C – The effective portion of gains and losses on hedging instruments in a Cash flow hedge
- R - Revaluation surplus related to property, plant and equipment
- A - Actuarial gains and losses on defined benefit pension plans
- A - Gains and losses on Available-for-sale financial assets
- F - Financial liabilities designated as at fair value through profit or loss: fair value changes attributable to changes in the liability’s credit risk (IFRS 9)
- T - Gains and losses arising from Translating the financial statements of a foreign operation
There are many doubts as accountants are not sure whether a particular item is OCI or P&L and why other comprehensive income is also called as equity account, if it has anything to do with statement of changes in equity. What is the difference between other comprehensive income and profit or loss? What is the difference between other comprehensive income and changes in equity?
The answers to the above questions is in "Net Assets" of an organization. Net assets are contracts’ evidencing total assets less total liabilities of a company. It is the same as Equity which is the residual interest in the assets of an entity after deducting all of its liabilities. So equity will therefore consists of share capital, share premium, reserves, retained earnings or losses, etc.
Net assets or equity changes because of the following:
- shareholders contribute cash to the company (share application money)
- profit or loss of the company for the year
- buy back of own shares back from the market
- dividend payment to shareholders
- revaluation of certain assets directly through equity (e.g. available for sale financial assets) and not through profit or loss
The key to understand the difference between profit or loss, other comprehensive income and changes in equity is to understand where these changes are coming from.
We can classify changes in net assets or equity into 2 main categories:
1. Capital changes – these are all changes related to owners of the company:
- Issuance of new shares
- Dividends payment to shareholders
- Buy-back of own shares from the market
All capital changes must be reported in the statement of changes in equity.
2. Revenue changes – these are all changes coming from the activities of the company and not from the owners. Revenue changes are further sub divided into 2 categories:
- Changes resulting from main operating activities of the company that are reported in profit or loss. For example:
- Revenue from sales of goods or services
- Expenses incurred to make sales of goods or services
- All other income and expenses, such as finance, administrative, marketing, personnel, etc.
- Gains related to primary performance (sale of property, plant and equipment, etc.)
All these changes are reported in profit or loss.
- Changes resulting from other, non-primary or non-revenue producing activities of the company that are not reported in profit or loss as required or permitted by other IFRS standard. For example:
- The effective portion of gains and losses on hedging instruments in a Cash flow hedge
- Revaluation surplus related to property, plant and equipment
- Actuarial gains and losses on defined benefit pension plans
- Gains and losses on Available-for-sale financial assets
- Financial liabilities designated as at fair value through profit or loss: fair value changes attributable to changes in the liability’s credit risk
- Gains and losses arising from Translating the financial statements of a foreign operation
This list is exhaustive and the standard setters do not think of other items that should potentially belong here. All these changes are reported in other comprehensive income.
The reason for introducing other comprehensive income and merging it with profit or loss into the statement of comprehensive income was to distinguish between capital and revenue changes.
The company needs to show clearly why its net assets go up or down – is it due to capital change or revenue change?
If you answer these questions, you will exactly understand why OCI has only 6 components. Remember CRAAFT..
