FCFF and FCFE Ratios
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‘Comprehensive income’ and ‘other comprehensive income’ are two components of the income statement that can have a material effect on the profitability of a company. It is therefore very important to understand the difference between these two items and the impact they may have on financial ratio analysis.
IFRS describes ‘total comprehensive income as “the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners.”
US GAAP describes ‘comprehensive income’ as “the change in equity [net assets] of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.”
Even though these definitions are slightly different, comprehensive income includes similar items under both IFRS and US GAAP. These similar items include both net income and other revenue and expense items that are excluded from the net income calculation, i.e., ‘other comprehensive income.’
The best way to demonstrate the computation of comprehensive income is the use of an an example.
A company’s beginning shareholders’ equity is $500 million, its net income for the year is $50 million, its cash dividends for the year is $5 million, and the company did not issue or repurchase any of its stock. If the company’s actual ending shareholders’ equity is $570 million, what is its comprehensive income?
Solution
Since the ending shareholders’ equity is $570 million, then [$570 –($500 + $50 – $5)] million = $25 million has bypassed the net income calculation and is classified as ‘other comprehensive income.’ Total comprehensive income is therefore equal to net income + other comprehensive income = $50 million + $25 million = $75 million.
Question
Which of the following best describes comprehensive income?
- Comprehensive income is another term for revenue.
- Comprehensive income includes only revenue and expense items that are excluded from the net income calculation.
- Comprehensive income includes all changes in shareholders’ equity during a period except those resulting from investments by owners and distributions to owners.
Solution
The correct answer is C.
Comprehensive income describes all changes in shareholders’ equity except those resulting from investments by owners and distributions to owners.
A is incorrect because revenue describes all the income generated by a company, while comprehensive income describes all the changes in shareholders’ equity during a period except those which result from investments by owners and distributions to owners.
B is incorrect because comprehensive income includes not only revenue and expense items that are excluded from the net income calculation (other comprehensive income), but also net income.