Marisa Agostini, Carlo Marcon. University Ca Foscari of Venice, Venice, Italy

Journal of Modern Accounting and Auditing, ISSN 1548-6583 January 2013, Vol. 9, No. 1, 1-19 D DAVID PUBLISHING Comprehensive Income (CI) Statement...
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Journal of Modern Accounting and Auditing, ISSN 1548-6583 January 2013, Vol. 9, No. 1, 1-19

D

DAVID

PUBLISHING

Comprehensive Income (CI) Statement’s Compliance With International Accounting Standard (IAS) 1 (Revised 2007 and 2011): Evidence From Italian Listed Corporate Groups Marisa Agostini, Carlo Marcon University Ca’ Foscari of Venice, Venice, Italy

The move towards international harmonization of accounting standards has dominated the work program of International Accounting Standards Board (IASB) in the past years. This paper aims to verify the compliance of the comprehensive income (CI) statement format with International Accounting Standard (IAS) 1⎯presentation of financial statements, which was revised in 2007. The changes introduced by the 2011 revision are also taken into account. For this purpose, this study analyzes the final annual financial statements approved in 2011 by the Italian companies whose shares belonged to the Italia Star segment of Financial Times and Stock Exchange (FTSE). Given that IAS 1 provides little specific guidance about the presentation of line items and permits many alternative types of format, this paper focuses on information organization in the statement of CI in order to analyze the degree of heterogeneity of financial information. For achieving this goal, this study considers the following issues: (1) presentation of all items of income and expense in an overall statement or in two separate statements; (2) a detailed level of the content in terms of number of items between revenue and net income (NI); (3) classification of expenses either by nature or by function; (4) number and type of intermediate margins; and (5) presentation of items of other comprehensive income (OCI) either before tax or net of tax. The results show some clear evidences. On the one hand, there is a high diversity in accounting practices, which makes it difficult for users to compare financial information across entities, highlighting the need to complete the joint project of the standards setters (IASB and Financial Accounting Standards Board (FASB)) on financial statement presentation. On the other hand, some alternative types of presentation (e.g., the tendency to split the CI statement into two statements rather than using an integrated solution, the prevalence to disaggregate the expenses by nature, etc.) are used by most of the entities of the sample possibly because of the influence of Italian accounting culture. Keywords: statement of comprehensive income (CI), separate income statement, other comprehensive income (OCI), Financial Times and Stock Exchange (FTSE) Italia Star segment, reporting format

Introduction Accounting doctrine has recently asked a radical revision of International Accounting Standard (IAS) Marisa Agostini, research fellow, Department of Management, Advanced School of Economics, University Ca’ Foscari of Venice. Carlo Marcon, assistant professor, Department of Management, University Ca’ Foscari of Venice. Correspondence concerning this article should be addressed to Marisa Agostini, research fellow, Department of Management, Advanced School of Economics, University Ca’ Foscari of Venice, San Giobbe, Cannaregio 873, 30121 Venice, Italy. Email: [email protected]. Tel.: +39 041-234-9256; Fax: +39 041-234-9176.  

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1⎯presentation of financial statements, namely, the role of the statements and the objective of the first accounting standard should be revised, another statement should be introduced in order to take into account both risk and expected cash flow, and qualitative characteristics (such as comparability, verifiability, timeliness, and understandability) should be enhanced according to the pervasive constraints represented by cost (Barth, 2012). According to these considerations and in spite of the convergence process of International Accounting Standard Board (IASB) and Financial Accounting Standard Board (FASB), the last revision (introduced in 2011 and implemented since July 2012) has not implied a radical change of the examined accounting standard. It has confirmed the existing IAS 1 option for the income statement to be presented either as a single statement of comprehensive income (CI) (statement of profit or loss and other comprehensive income (OCI)) or two statements (i.e., a separate statement of profit or loss and another statement of OCI). The amendments have just clarified that the statement (or section of the single statement) which sets out profit or loss is required to be followed directly by the statement (or section of the single statement) that sets out OCI. Moreover, IAS 1 permits entities to present components of OCI either net of related tax effects or before tax with one amount shown for the aggregate amount of income tax relating to those components. Entities will continue to have this choice of tax presentation. In addition, a change has been made to the title of the statement of CI. This is now referred to as the “statement of profit or loss and OCI”. However, the flexibility in IAS 1 to use other titles will remain currently. For example, an entity may use the title “statement of CI” instead of “statement of profit or loss and OCI”. So, IAS 1 continues to provide little specific guidance about the presentation of line items and permits many alternative types of formats also after the last revision. The main change is still represented by the 2007 revision. For this reason, the present piece of research aims to analyze the application of IAS 1 (revised 2007) to the “new” statement of CI, in order to verify the degree of compliance implemented by the examined listed corporate groups. In particular, the analysis considers the consolidated annual reports approved in 2011 by Italian companies (whose shares belong to the Italia Star segment of the Financial Times Stock Exchange (FTSE)) and focuses on information organization in the statement of CI. The results regard both the degree of heterogeneity of financial information and the existence of some alternative explanations (such as those related to country factors). The present work may be useful to both firms called to present financial statements according to IAS 1 (revised 2007 and 2011) and to standard setters called to improve the actual regulation. This provides only general guidelines about both the structure and the content of the statements. It may be disorienting for companies (such as Italian ones) that have traditionally considered a stricter regulation about financial statement presentation. For this reason, the investigation of the solutions adopted by Italian companies, called upon to apply International Financial Reporting Standards (IFRS), may be really interesting. This paper is organized as follows. The next section describes several alternatives allowed by IAS 1 revised in 2007 in the presentation of CI statement, in order to highlight the great flexibility of the first international accounting standard. The third section reviews the relevant literature by introducing a brief overview of other empirical studies that deal with the issue of CI presentation. Section four describes the sample and introduces the analysis performed in consolidated annual reports. Section five illustrates some empirical evidences and discusses the findings. Finally, some concluding remarks are presented.

The Statement of CI According to Revised IAS 1  

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The international standard dealing with the presentation of financial statements is IAS 1. It prescribes general guidelines for their structures and minimum requirements for their contents. This standard applies equally to all entities, including those entities that present consolidated financial statements and those that present separate or stand-alone financial statements as defined in IAS 27 (consolidated and separate financial statements). It does not apply neither to the structure and content of condensed interim financial statements prepared in accordance with IAS 34 (interim financial reporting) nor to those entities applying IFRS for smalland medium-sized enterprises (SMEs). In September 2007, the IASB released a revised version of IAS 1, effective for annual periods beginning on or after January 1, 2009, in order to bring it largely into line with the corresponding US Statement of Financial Accounting Standard (SFAS) 130 (reporting CI). In fact, the revised IAS 1 is resulted from the IASB’s deliberations on phase A of the financial statement presentation project, which is a joint project of the IASB and the US FASB (carried out independently by IASB and FASB prior to April 2004) to establish a common standard that would improve how information is organized and presented in the financial statements. Several changes were introduced in IAS 1 by the 2007 revision. On the other hand, as emphasized in the previous paragraphs, the 2011 revision did not imply a radical change of the examined standard. The main change arising from 2007 revision is the introduction of the statement of CI in replacement of the traditional income statement. The previous version of IAS 1 is required to present the items of OCI, namely, the items of income and expense that are not recognized in profit or loss, exclusively in the statement of changes in equity. Thus, it was not permitted to present these components in the income statement, even though they met the definitions of income and expense contained in the conceptual framework of IASB. The current version of IAS 1, as revised in 2007, now requires items of OCI to be displayed in the statement of CI, where it is necessary to give clear evidence to total CI. This sort of all-inclusive income concept represents the change in equity of an entity during a period resulted from transactions and other events arising from non-owner sources. Therefore, it includes all changes in net assets during a period, except those resulted from contributions by owners and distributions to owners. It comprises all components of profit or loss and OCI presented in the statement of CI. Profit or loss (or net income (NI)) is the total of income less expenses, excluding the components of OCI, while OCI comprises items of income and expense (including reclassification adjustments) that are not recognized in profit or loss as required or permitted by other IFRSs. In substance, the CI is a notion of income which, including all items of income and expense recognized during the reporting period, both realized and realizable, aims to represent a measure of the overall performance of an entity. The judgment on this innovation can be considered definitely positive for several reasons (Pisani, 2011). Concerning this, the authors point out several observations. Firstly, the CI comprises all items of non-owner changes in equity which meet the definitions of income and expense in the conceptual framework of IASB by aggregating items with shared characteristics. Secondly, the statement of CI is able to fully play its own role by highlighting all analytical components of the performance of an entity. On the contrary, the statement of changes in equity can in turn play its right function, namely, the reconciliation between the carrying amount for each component of equity at the beginning and the end of the period and avoid being the tool for representing the overall performance. Moreover, the traditional and close link between income and capital in the preparation of financial statements is restored again. In fact, the bottom line of the statement of CI equals to the total changes in equity during a period resulted from events other than those arising from transactions with owners. Thereby, the CI allows recovering the informational value of income notion. A  

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negative CI means a decrease of equity and the vice versa. Finally, most of the users of financial statements tend to overlook the financial information presented in the statement of changes in equity. Brown (1997) showed that financial analysts regarded this statement among the least useful components of an annual report. Accordingly, reporting the OCI only in the statement of changes in equity would risk preventing a full understanding of the real entity performance by users. A considerable number of empirical researches, carried out with different methods and objectives, support the IASB’s decision not to present the CI exclusively in the statement of changes in equity, as will be illustrated in the next paragraph. As regards the way of presentation of the CI statement according to IAS 1, an entity has the option of presenting CI in a period either in a single overall statement (in which all items of income and expense are recognized in the period⎯the one-statement approach) or in two separate statements (the two-statement approach), namely, a statement displaying components of profit or loss (separate income statement) and a second statement beginning with profit or loss and displaying components of OCI. The IASB initially intended to introduce the single-statement approach for the statement of CI, but during discussions with constituents, many of them were opposed to the concept of a single statement, stating that it could result in undue focus on the “bottom line” of the statement. The IASB’ s decision to permit the choice of displaying non-owner changes in equity in one statement or two statements reflects a situation in which there are many mixed views. On the one side, the preference for the single statement is based on several reasons. Firstly, the conceptual framework does not define profit or loss nor provide criteria for distinguishing the characteristics of items that should be included in profit or loss from those items that should be excluded from profit or loss. Thus, reporting all non-owner changes in equity in a single statement is considered more conceptually correct, because there are no clear principles that can be used to separate income and expense into two statements (basis for conclusions 51, IAS 1). Secondly, this choice is fully consistent with the underlying assumptions of the “clean surplus accounting”. Thirdly, this alternative should be more understandable than the two-statement format. In fact, presenting two separate statements with two different bottom lines could generate some confusion in the users of financial statements and create some doubts on which income notion is more value-relevant (Copnell, 1999; Barker, 2003). Moreover, such a solution does not make the preparation of financial statements more complicated, introducing a new statement. Finally, users could overlook the items of OCI presented in an integrative and separate statement, paying greater attention to the traditional income statement (The Institute of Chartered Accountants in England and Wales, 1997; Beale & Davey, 2001). On the other side, there are some believable reasons to support the two-statement approach. Firstly, such an alternative allows displaying all income and expense recognized in a period through a performance statement by maintaining a familiar structure for representing the income. Secondly, a single statement would undermine the importance of profit or loss as a measure of performance by making it a simple subtotal, while the CI as the bottom line of the single statement would receive undue attention. In particular, the supporters of NI believe that the CI has a low predictive value because of some non-recurring components and is beyond the control by management, which could determine some interpretation errors (Tarca, 2006). Finally, the one-statement approach is considered by supporters of NI as the first step towards eliminating the notion of profit or loss. In the light of these different views, the IASB decided that an entity should have the choice of presenting all income and expense recognized in a period in one statement or in two statements. This is a compromise solution that IASB has accepted as transitory, until it develops robust principles to determine the criteria for the inclusion of items in profit or loss or in OCI and addresses the other aspects of presentation,  

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namely, deciding what categories and line items should be displayed in the CI statement. The option between the abovementioned one or two statements is only one of the many alternatives allowed by IAS 1. As for the statement of financial position, IAS 1 does not prescribe a standard format for the statement of CI that must be adopted. Rather, it provides a minimum content of line items that are considered to be of sufficient importance to the reporting of the performance of an entity to warrant their presentation on the face of the CI statement. Furthermore, IAS 1 also requires additional line items, headings, and subtotals to be presented on the face of the statement, when such a presentation is relevant to an understanding of an entity’s financial performance. However, IAS 1 specifically prohibits the inclusion of any items of income and expense as “extraordinary items” either on the face of the statement or in the notes. Another important aspect related to the presentation of CI statement regards the classification of operating expenses. In this respect, IAS 1 offers preparers two kinds of alternatives, such as displaying this disaggregation on the face of the statement or in the notes and classifying operating expenses by nature or by function. While entities are encouraged to apply one or the other of these ways of classification on the face of the income statement, putting it in the notes is not prohibited. An entity should present an analysis of expenses within profit or loss using a classification based either on the nature of expenses or on their functions within the entity, whichever provides information that is reliable and more relevant. The classification by nature identifies costs and expenses in terms of their characters, such as salaries and wages, raw materials consumed, and depreciation of plant assets. On the other hand, the classification by function presents the expenses in terms of the purpose of the expenditure, such as for manufacturing, distribution, and administration. IAS 1 furthermore requires that if a reporting entity discloses expenses by function, it must also provide information on the nature of the expenses, including depreciation, amortization, and staff costs. With regard to the presentation of OCI, IAS 1 requires to disclose the amount of income tax relating to each component of OCI on the face of the statement of CI or in the notes. These components can be presented either net of tax or before tax effects with one amount shown for the aggregate amount of income tax relating to those components. Moreover, an entity should disclose reclassification adjustments relating to each component of OCI directly on the face of CI statement or in the notes. To sum up, all these requirements give to preparers of financial statements a great discretionary freedom in selecting the line items, their descriptions and their orderings, the classification criteria, the main categories, and the relevant subtotals which allow reflecting appropriately the underlying nature of entity performance and maximize the usefulness of the information being reported. On the one hand, the flexibility allowed by the current IAS 1 is the only way that permits the preparers to choose the format which fits well for representing the performance. In fact, business models can differ so much from one sector to the other that any standardization beyond the existing requirements will be to the detriment of the users, because it will prevent entities from portraying their performance in the optimal way. On the other hand, it can be argued that without requiring a standard format and mandatory disaggregation criteria, comparability amongst entities is difficult even in the same industry. As a matter of fact, the existing requirements of IAS 1 allow such a wide range of presentation formats, especially for the statement of CI. The authors can have statements with a very concise content or, in alternative, a very analytical content; there can be several subtotals (In theory, an entity could report a subtotal before and after any line items) or even no one; some entities may highlight the gross profit and others may highlight the earnings before interest, tax, depreciation, and amortization (EBITDA); some terms could be used with different meanings (for example, the term “operating”) or, on the contrary, different  

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labels could have the same meanings; some entities may adopt the “revenue and cost of sales” approach, others may follow the “production value and production costs” approach; and so on.

Literature Review Most empirical studies relating to CI focus on the value relevance of this income notion. Generally, this type of research uses linear regression models to estimate the correlation between such an income notion (or its single components) and stock prices or returns. The results of this empirical research are very mixed and conflicting. On the one hand, some tests show that CI is more value relevant than NI (Biddle & Choi, 2006; Hodder, Hopkins, & Whalen, 2006; Kanagaretnam, Mathieu, & Shehata, 2009) or point out the incremental value relevance of individual items of OCI (Bartov, 1997; Louis, 2003; Pinto, 2005; Roberts & Wang, 2009). On the other hand, some tests underline that there is not a clear evidence of the most value relevance of CI compared with NI (Cheng, Cheung, & Gopalakrishnan, 1993; Dhaliwal, Subramanyam, & Trezevant, 1999; O’Hanlon & Pope, 1999; Isidro, O’Hanlon, & Young, 2004; Wang, Buijink, & Eken, 2006; Ernstberger, 2008; Barton, Hansen, & Grace, 2010; Mechelli, 2011). Only a minority of empirical surveys on the CI addresses the matter of its presentation. Such a research field can be divided into three main groups (Pisani, 2007): (1) Studies which analyze the actual behaviors of entities when representing CI; (2) Studies geared to assess the influence of CI presentation format on the users of financial statements; (3) Studies aiming to verify the impact of the presentation format of CI on the stock prices. The surveys belonging to the first group were developed mainly in the US context, in order to analyze how companies applied the SFAS 130, which allowed three alternatives for presenting CI: (1) a single overall statement; (2) two separate statements; and (3) the statement of changes in stockholders’ equity (The third option was eliminated by FASB on June 16, 2011). The first empirical evidence comes from a study by Campbell, Crawford, and Franz (1999) on a sample of 73 American companies that applied SFAS 130 a year earlier than the effective date, that is, in 1997. Thirty nine companies adopted the choice to present the CI in the statement of changes in stockholders’ equity, 22 in a separated statement of CI, and the remaining 12 in a combined statement of NI and CI. Furthermore, they show that entities with negative amounts of OCI have the tendency to report them in the statement of changes in equity, possibly for reducing the importance of CI as a measure of performance and emphasizing the role of traditional NI. On the contrary, entities with positive and material amounts of OCI prefer to present them through a statement of performance. However, Bhamornsiri and Wiggins (2001) carried out a test on a sample of 100 US companies for the period of 1997-1999, but they did not find evidence for confirming the results emerged from the previous study by Campbell et al. (1999). Although examined companies have a great preference for the statement of changes in equity, this does not depend on the direction and the size of OCI according to the authors. Jordan and Clark (2002) collected data from 100 randomly financial service firms for 1998 (the first year that SFAS 130 was implemented). They found that only 37% of the firms chose a performance-based reporting option, 12% used the combined statement of NI and CI, and 25% used the separate statement of CI, while 63% chose to adopt the statement of changes in stockholders’ equity. The authors also found that there is a correlation between the direction and size of OCI and its choice of reporting format. In particular, entities with  

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negative OCI have a greater tendency to report CI in a statement of changes in equity than entities with positive OCI. Findings to some extent similar to those of Campbell et al. (1999) and Jordan and Clark (2002) emerging from the study of Pandit and Phillips (2004). They randomly collected a sample of financial statements prepared by 100 New York Stock Exchange (NYSE)-listed companies in 2002. Their research indicated that 89% of the companies applied the statement of changes in equity, 9% of the firms elected to implement a separate CI statement, and only 2% displayed CI in a single overall statement. Pandit and Phillips (2004) observed that entities possessing negative OCI were almost twice as likely to present in the statement of changes in equity, even though FASB preferred them to show OCI items either in the income statement or in a separate statement of CI. Finally, Ferraro (2011) carried out an empirical study focusing on the format preferences of CI reporting by a sample of 160 Italian listed companies, applying for the first time the revised IAS 1 in their financial statements closing on December 31, 2009. This survey showed that a large majority of companies (86% of the sample) chose the option to present two separate and successive statements rather than a single one. Moreover, such a choice seems to depend on the direction and size of OCI. There are some evidences that entities with positive NI and material negative OCI tend to opt for the second integrative income statement, in order to highlight NI as a measure of performance. Another survey, which examined the interim financial reporting of a sample of Italian listed groups, was the one by D’Este and Fellegara (2009) aiming to show how entities apply for the first time the provisions of revised IAS 1 related to the presentation format of OCI. To summarize, the pieces of this research appear to point out that management’s discretionary freedom in drawing up financial statements is used to emphasize the income notion (NI or CI) whose value is higher. The second group of empirical studies shows that reporting format of CI affects the economic decision-making process of the users of financial statements. This may seem like a rather unsurprising issue, but the finance theory would argue the opposite, that is, location and format of financial information are irrelevant in a world of efficient markets. Hirst and Hopkins (1998) performed experiments with professional analysts, in which the participants were asked to evaluate a hypothetical company. The financial statements of the company contained CI information revealing that the company actively managed earnings by selective sales of available-for-sale securities. They found that analysts detected the earnings management more easily, when viewing CI in the income statement-type format, as compared with when viewing it in the statement of changes in equity. King, Ortegren, and Reed (1999) and Hunton, Libby, and Mazza (2006) showed similar results, namely, the CI statement provided more transparency of financial information compared with the statement of changes in equity and made it easier to uncover evidence of earnings management. Maines and McDaniel (2000) examined the matter of reporting location using non-professional participants. In their experimental test, they provided 95 MBA students with several different presentation locations, including the income statement-type format and the statement of changes in equity. As they predicted, there was little difference in the participants’ abilities to find information related to CI, regardless of the reporting location. However, there was a significant difference in their abilities to identify the volatility of income, giving more weight when CI was reported in the statement of performance. In other words, non-professional investors’ judgments of corporate performance reflect the volatility of CI only when its presentation is in the statement of CI.  

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COMPREHENSIVE INCOME STATEMENT’S COMPLIANCE WITH IAS 1 The third group of empirical studies aims at assessing whether different presentation formats of CI affect

the market prices of stocks. Such a research does not show clear evidences. Cahan, Courtneay, Gronewoller, and Upton (2000) carried out a survey on a sample of 48 entities from New Zealand. The results underline that the presentation of CI in the statement of changes in equity is not more value relevant than presenting it in the notes or wherever else (however, this study does not compare the alternative to present CI in a performance statement). Similarly, some pieces of researches (Smith & Tse, 1998; Dehning & Ratliff, 2004; Owusu-Ansah & Yeoh, 2006) do not find any correlation between stock prices and CI presentation format. Conversely, Bloomfield, Nelson, and Smith (2006) demonstrated that the volatility of stock prices increased when the OCI items were presented in a performance statement rather than in a statement of changes in equity. Finally, Chambers, Linsmeier, Shakespeare, and Sougiannis (2007) examined how stock price returns for Standard and Poor’s 500 index companies were affected by CI reporting location. The sample covered the 4-year period after the implementation of SFAS 130 (1998-2001). They found evidence that OCI information was included in stock price returns, when it was disclosed in the statement of changes in equity, while the OCI information was less value-relevant, when it was reported in the statement of CI. The abovementioned pieces of researches focused on the presentation of OCI. In fact, at the international level, the matter of presenting CI is mostly considered as a matter of how the items excluded from NI (OCI) are displayed. Even though the authors of this work consider the presentation of OCI as an important issue, they are also interested in analyzing the other aspects relating to the presentation of CI through the study of actual behaviors implemented by Italian listed entities applying the revised IAS 1. Thus, the present study not only addresses the option between a single or two-statement approach, but also the other alternatives permitted by IAS 1. Thereby, it is more likely to highlight the heterogeneity in accounting practice which could suggest more standardization and less flexibility in the presentation format.

Sample The first criterion used in the sample selection regards the consideration of Italian companies1 required to apply IASs (IFRS). The Legislative Decree 38/2005 has distinguished among Italian entities which must (i.e., in a mandatory way) or could (i.e., in an optional way) apply international accounting standards. In fact, according to this law, certain types of companies (e.g., listed companies, companies with financial instruments that are widely distributed, banks, and financial intermediaries and insurance companies) must have applied IFRS since January 1, 2005. Among the abovementioned categories, specific companies’ categories require particular attention. Banks, insurers, and other financial institutions are subjected to specific regulations. For this reason, these companies are excluded from the sample. Entities which are “authorized” but not required to apply IFRS (i.e., the companies identified by Article 2, Letters “e”, “f”, and “g” of the Legislative Decree 38/2005) may adopt this option with respect to both the consolidated and annual financial statements. About this class of companies, there is the risk not to obtain updated information. 1

The choice to investigate Italian companies’ statements has already been explained in the introduction.  

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For these reasons, the sample choice regards listed corporate groups. Specifically, the Italian stock market (MTA2) is divided into three segments. The capitalization is more than 1 billion euro for the Blue Chip segment. It is between 40 million and 1 billion euro for the Star segment. The standard segment is dedicated to the companies of smaller size than the previous ones. Given the peculiarities of the Italian economy, the authors exclude from the analysis the Blue Chip segment. Thus, the sample considers 62 listed corporate groups belonging to the Star segment which includes companies complying with requirements of excellence and companies that are forced to make available more information than the standard-segment companies (see Table 1). In fact, the FTSE Italy Star or High Requirement Securities Segment welcomes companies of medium size, which must observe quite restrictive requirements in order to be included in the segment (e.g., high transparency, high disclosure requirements, high liquidity, i.e., a minimum 35% of free float, and corporate governance in line with international standards). Table 1 List of the Sampled Companies, Belonging to the Star Segment and Indicating Their Inclusion on the Basis of the Activity Code Name Acotel Group Aeffe Amplifon Ansaldo Sts. Ascopiave Astaldi Biancamano Biesse Bolzoni Brembo Buongiorno Cad It Cairo Communication Cembre Cementir Holding Centrale Latte To Cobra D’Amico Dada Damiani Datalogic Digital Bros Dmail Group Dmt Eems El.En. Elica Emak Engineering 2

Activity sector Telecommunications Consumer goods Health sector Industry Public services Industry Industry Industry Industry Consumer goods Telecommunications Technology Consumer services Industry Industry Consumer goods Consumer goods Industry Technology Consumer services Industry Consumer goods Consumer services Technology Technology Industry Consumer goods Consumer goods Technology

Mercato Telematico Azionario (MTA) is the online Italian stock market.  

Capitalization 105,532,275 61,250,309 735,641,830 1,018,836,000 339,732,696 428,295,952 46,637,800 95,974,262 43,495,618 498,659,453 124,143,450 27,424,920 226,224,402 116,375,200 275,070,744 19,142,000 32,758,051 82,442,459 38,216,859 80,658,900 319,135,375 17,422,650 15,670,260 186,795,580 31,450,962 48,842,867 60,017,350 65,154,411 286,688,750

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(Table 1 continued) Name Esprinet Eurotech Exprivia Falck Renewables Fidia Fiera Milano Gefran I.M.A. Interpump Group Irce Isagro It Way La Doria Landi Renzo Marr Mondo Tv Nice Panariagroup Poligraf. S. F. Poltrona Frau Prima Industrie Rdb Reno De Medici Reply Sabaf Saes Getters Servizi Italia Sogefi Ternienergia Tesmec Txt E-Solutions Yoox Zignago Vetro

Activity sector Technology Technology Technology Public services Industry Industry Industry Industry Industry Industry Chemistry and raw material Technology Consumer goods Consumer goods Consumer services Consumer services Industry Industry Industry Consumer goods Industry Industry Industry Technology Industry Industry Industry Consumer goods Public services Industry Technology Consumer services Industry

Capitalization 147,722,594 58,128,684 36,816,857 245,020,800 14,937,131 157,989,668 40,970,880 514,174,122 466,992,255 54,182,966 51,193,350 9,736,190 50,158,000 162,168,750 498,812,002 18,076,784 321,227,200 45,999,336 5,819,003 115,965,474 60,498,697 18,110,519 62,811,243 149,062,582 161,978,078 87,749,344 78,879,420 278,404,564 77,041,926 42,598,015 29,884,578 555,115,410 398,096,000

The financial statements of all the 62 sampled listed corporate groups refer to 2010 exercise, which coincides with the calendar year of 2010 with the exception of three groups: (1) Damiani, whose report was closed on March 31, 2011; (2) Digital Bros, whose report was ended on June 30, 2011; and (3) It Way, whose report was closed on September 30, 2010. In next section, the analysis is divided into two steps. Some descriptive statistical results are followed by some evaluations about some outliers emerged from the analysis in particular.

Analysis and Results Variables Each sampled company has a dedicated website, which is constantly updated with information available in both Italian and English languages. Moreover, the Italian Stock Exchange website provides consolidated annual

 

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reports of the companies analyzed here (i.e., those listed in the previous paragraphs). As emphasized in the introduction, one of the research objectives regards the exploration of the solutions adopted by Italian companies required to apply IAS 1 (revised in both 2007 and 2011). Therefore, several aspects which emerged from IAS 1 study have been investigated. As already mentioned, IAS 1 provides only general guidelines about both the structure and the content of the statements. This may be much disorienting for companies (such as Italian ones) that have traditionally considered a stricter regulation about financial statement presentation. For this reason, the investigation of the solutions adopted by Italian companies called to apply IFRS may be really interesting. First of all, two different ways of drawing up the statement of CI are allowed by IAS 1: either a single statement of CI or two consecutive documents. In this regard, it is interesting to consider both the number and the name given to the statement of CI to its main results (i.e., NI and CI) and to the margins exposed between revenues and NI. Because of the flexibility allowed by IAS 1, different choices may be adopted by the companies, and this may hamper the understanding and comparability of financial statements. Moreover, the number of intermediate margins collocated between revenues and NI, the reclassification adopted for the costs, and the choice to expose the OCI to the net or gross of tax (illustrated before) have been analyzed. Finally, the values of NI, CI, and equity have been emphasized for this research. Statistics and Results According to IAS 1 (revised 2007 and 2011), an entity may choose between two alternatives for the presentation of all the positive and negative components of income: An entity may present a single statement of profit or loss and other comprehensive income, with profit or loss and other comprehensive income presented in two sections. The sections shall be presented together, with the profit or loss section presented first followed directly by the other comprehensive income section. An entity may present the profit or loss section in a separate statement of profit or loss. If so, the separate statement of profit or loss shall immediately precede the statement presenting comprehensive income, which shall begin with profit or loss3.

In the latter case, the first statement represents a separate statement of profit (or loss). It should be followed by the second statement presenting CI, i.e., other components of CI, excluded from the traditional calculation of profit, because they are recorded in return for equity items. This second option (i.e., the use of two income statements) appears as a compromise solution to facilitate all entities having more familiarity with traditional NI, like Italian entities called to switch from Italian (OIC, i.e., Organismo Italiano di Contabilità or Italian standard setter) standards to international ones. In fact, according to IFRS, entities must provide both the algebraic sum of positive and negative components of annual income (i.e., the traditional “costs” and “revenues” recorded according to the accrual principle) and the algebraic sum of fair value changes for certain assets and liabilities (calculated in accordance with the usual IFRS valuation procedures at the end of each year) which are far from the traditional Italian reporting. The separation allowed by the second alternative seems to have been considered as “facilitation” and largely adopted by the examined sample. In a total of 62 corporate groups, only six entities have chosen to use a single statement of profit or loss and OCI (see Figure 1). The remaining 56 entities (i.e., 90% of the sample) have adopted the other option.

3

IAS 1, Par. 10A.  

12

COMPREHENSIVE INCOME STATEMENT’S COMPLIANCE WITH IAS 1

10%

One statement Two statements 90%

Figure 1. Statement of profit or loss and OCI (two alternative formats).

With reference to the denominations which should be assigned to the examined statements, IAS 1 suggests a title (i.e., “statement of profit or loss and OCI”), but explicitly says that it is not mandatory: “An entity may use titles for the statements other than those used in this Standard. For example, an entity may use the title ‘statement of comprehensive income’ instead of ‘statement of profit or loss and other comprehensive income’”4. (IAS 1 revised 2011, Par. 10). In the first alternative (i.e., just one income statement), only an entity of the six sampled corporate groups which have chosen this solution has adopted the title proposed by the standard, two entities have opted for the name “CI”, an entity for the “statement of profit or loss”, and the remaining two entities for the name “income statement and CI”. As regards the second option (i.e., two separate income statements), IAS 1 suggests the abovementioned names (“separate statement of profit or loss” and “statement of CI”). In the authors’ opinion, these are optional yet effective denominations. The authors expect that compared with the previous option, the sampled groups make more reference to the IAS 1 proposal because of the importance of clearly distinguishing the two income statements which disclose very different pieces of information and are (in part) far from the traditional Italian financial reporting. As mentioned above, 56 sampled entities have chosen the second option. Regarding the first statement, four different results were found: Six groups (i.e., 11% of the sample) have adopted names similar to those proposed by IAS 1 (“separate income statement”), and an entity has chosen the title “statement of separate income”. Both the names are in line with the suggestion made by the IASs. On the other hand, the remaining groups have opted for a different title: Two groups chose “statement of income”, and as many as 47 entities (i.e., 84% of the sample) adopted the term “income statement”. This seems to indicate a strong link with the Italian doctrine that puts all the traditional positive and negative components of income under the generic name income statement (see Figure 2). Therefore, in this second alternative (i.e., two separate income statements), few entities have adopted IAS 1 proposal for the income statement. The expectation of compliance is better seen with reference to the statement that follows the one just examined (see Figure 3). The adopted solutions are in line with the IAS 1 proposal. The name (“statement of OCI”) chosen by a sampled group must be highlighted. This title anticipates the 2011 revision (implemented since July 2012), underlines the most peculiar aspect of the second statement, and seems 4

IAS 1 revised 2011, Par. 10.  

COM MPREHENSIIVE INCOME E STATEME ENT’S COMP PLIANCE WIITH IAS 1

13

to emphasiize how muchh both the traansition to IF FRS and the revision r of IA AS 1 in 2007 have been perceived by 5 the Italian sampled grooups. In factt, the most peculiar p aspecct of this reevision has bbeen represen nted by the aggregate of o “other com mponents” (O OCI). This inccludes items of o income annd expenses w which are nott recognized in the annuual profit or loss l and seem ms quite far from f the trad ditional Italiann reporting. A As required or o permitted by IFRS, this t aggregatte includes fair fa value chaanges which should be reecognized inn return for a reserve in equity.

Sttatement of inncome

Separatee income stateement

Income stateement 0%

20%

40% %

60%

80%

1000%

% of sampled enntities Figure 2. The T first statemeent in the secon nd option alloweed by IAS 1.

Statement of other comprehensivve income

Stateement of compprehensive income

Comprehensivve income

0% %

50% % of saampled entitiees

1000%

Figure 3. The second statem ment in the seco ond option allow wed by IAS 1.

t title of the statement oof profit or loss and OCI, IAS 1 permits entitties to choosee not only thee format and the but also a great g part of its content. In I order to annalyze the parrtial results and a all the enntries collocatted between 5

“All non-oowner changes in i equity (i.e., comprehensive c income) are reequired to be prresented in one statement of co omprehensive income or in i two statements (a separaate income staatement and a statement of comprehensivee income). Co omponents of comprehensiive income are not n permitted too be presented in i the statemen nt of changes in equity” (IAS 1, Par. IN6).  

14

COM MPREHENSIIVE INCOME E STATEME ENT’S COMP PLIANCE WIITH IAS 1

revenues and a NI in the income stateement, reference should be b made at thhe abovementtioned minim mum content that the exxamined stateement must present p (IAS 1, Par. 82). In the sampple, the miniimum numbeer of partial results colllocated betweeen revenuess and NI equaals one, whille the maxim mum number is seven. Thee arithmetic mean considering the enntire sample equals three, so is the med dian, while mode m is just tw wo. The presence of two intermediatte results hass emerged in 20 2 out of the 62 analyzed reports. Morreover, in ordder to verify th he presence of outliers,, the first andd the third quuartiles have been b calculated (see Tablee 2). Their vaalues equal tw wo and four respectivelly. Thus, the inter-quartille (IQ) rangee is two, and d the values below b (abovve), of which h the results represent anomalies, a caan be calculaated. The minnimum value not to be ann outlier is one, while thee maximum value (Aboove which, thhere is the preesence of an anomaly value) is seven. Therefore, thhe results em merged from the sample fall within thhe range (from m one to seveen). Table 2 Descriptivee Statistics Abbout the Parttial Results Between Reven nues and Net Income Range of varriation in the nuumber of intermediatee results Modde Minimum vaalue Maximuum value 1 7 2

Mean

M Median

First quartille

Third quartile

Minnimum Maaximum IQ range valuue not to be vallue not to be an ooutlier an outlier

3

3

2

4

2

1

7

After analyzing the number of intermediate results collo ocated betweeen revenues aand NI, the au uthors have examined the t names adopted to title them. Being their averagee equals threee, the names oof the three in ntermediate results, inccluded in mosst of the samppled income statements, s haave been conssidered. The inntermediate result r which appears a most of the time is i “earnings before b taxes”.. It has been included i by 52 sampledd groups. Its denominatioons are quite similar: 30 entities e (58% % of the sampple) have useed the name “earnings ante a taxes”, 18 entities (334% of the sample) s havee preferred thhe title “profiit/loss ante taaxes”, three entities havve adopted thhe name “proffit/loss ante taaxes from continuing operrations”, and an entity hass chosen the name “totaal earnings beefore taxes froom continuingg operations””.

Gross traading margin

10.50% %

EBITDA

10.50% %

(Industrial)) Gross profit

Gross operrating margin

26%

% of sam mpled entities

53%

0% 20% 400% 60% 80% % 100% Figure 4.. “Gross operatiing margin” (Itaalian MOL and d international EBITDA) E denom minations.

The second interm mediate resultt mostly incluuded in the analyzed a stateements is “opperating income”, which has been inncluded in 48 reports. In this case, thhe denominattions adoptedd have been oonly three: 40 corporate  

15

COMPREHENSIVE INCOME STATEMENT’S COMPLIANCE WITH IAS 1

groups (84% of the sample) have used the title “earnings before interest and taxes (EBIT)”, five corporate groups (10% of the sample) have preferred the designation of “operating profit/loss”, and three corporate groups (6% of the sample) have adopted the term “net operating income”. The last studied denomination is the “gross operating margin (MOL)”, which may be considered similar to the EBITDA. It has been included in 19 income statements with four titles which appear to be quite different (see Figure 4): 10 entities (53% of the sample) have chosen the name “gross operating margin” (MOL), five corporate groups have preferred the title “(industrial) gross profit”, two entities (10.5% of the sample) have opted for the name “EBITDA”, and the last two entities (10.5% of the sample) have used the denomination “gross trading margin”. In addition to the intermediate results, the number of entries between revenues and NI has been considered. The analysis shows that additional items not required by Par. 82 of IAS 1 have been collocated between the two “mandatory results”. The minimum number of entries between revenues and NI equals 10 and has been found in the statements of two groups, while the maximum number is 41 and has only emerged in the report of a corporate group. This is the case for the number of entries corresponding to 13, 15, and 20. The average number of total entries is 18, while the median is 17 (see Table 3). In order to check the presence of outliers in the analyzed sample, the authors have calculated the first quartile (equaling to 14), the third quartile (equaling to 21), and the IQ range. The minimum number of entries, below which there is the presence of an anomaly, is 10.5, while the maximum number, above which there is the presence of an outlier, is 31.5. In the sample, there have been two results above the maximum number: 37 and 41 items were found in the statements of two groups. Table 3 Descriptive Statistics About the Number of Entries Between Revenues and NI Range of variation in the number of intermediate results Mode Minimum value Maximum value 10 41 6

Mean

Median

First quartile

Third quartile

Minimum Maximum IQ range value not to value not to be an outlier be an outlier

18

17

14

21

7

10.5

31.5

As mentioned above, the IAS 1 (Par. 99) states that, “An entity shall present an analysis of expenses recognized in profit or loss using a classification based on either their nature or their function within the entity, whichever provides information that is reliable and more relevant”. In addition, it adds that, “The choice between the function of expense method and the nature of expense method depends on historical and industry factors and the nature of the entity” (Par. 105). For this reason, the authors have analyzed the criterion (i.e., classification by nature or by function) chosen by the sampled entities (see Figure 5): 89% of the entities belonging to the sample (55 groups of companies) have preferred the presentation of expenses by nature, while the remaining 11% of the sample (seven groups of companies) have adopted the presentation of expenses by function. In addition to the most chosen classification of expense method, it has been checked whether the entities adopting the method by function have observed the requirement of IAS 1 (Par. 104): “Entities classifying expenses by function shall disclose additional information on the nature of expenses, including depreciation and amortization expense and employee benefits expense”. Thus, the authors have analyzed in more details the statements of CI, where the classification by function has been applied. As said above, only seven groups (in a

 

16

COMPREHENSIVE INCOME STATEMENT’S COMPLIANCE WITH IAS 1

total sample of 62) have opted for this method. All the seven entities have followed the instructions of IAS 1 and reported (in the notes) additional information about the nature of expenses, including depreciation and amortization expense and employee benefits expense.

11%

Nature Function 89%

Figure 5. Choice between the function of expense method and the nature of expense method made by the sample.

With reference to the most peculiar aspect of IAS 1, revised 2007 (i.e., the aggregate of “other components” titled OCI), the research has firstly investigated the presence of a specific total amount and secondly the presentation of OCI either before or after tax effects. The requirement about the presence of a total OCI amount was not introduced by the 2007 revision. The OCI has been required since the 2011 revision (IAS 1, Par. 81A). Even though not required at the time of 2010 financial statements presentation, only 14 groups (23% of the sample) have chosen to not represent the aggregate value of these “other items” (OCI), while the remaining 48 groups (77% of the sample) have highlighted it.

40% 60%

OCI components already net of tax Specific OCI tax entry

Figure 6. OCI tax effects.

Regarding the tax issue, IAS 1 states that an entity may submit items of OCI component either net of related tax effects or inclusive of these effects (with a single value for the aggregate amount of taxes related to  

COMPREHENSIVE INCOME STATEMENT’S COMPLIANCE WITH IAS 1

17

these items). Therefore, the choice of the second approach requires the addition of a single entry putting together all the tax related to items of this prospectus. Conversely, if entities prefer the first setting, then there will not be a specific voice representing the entire OCI tax effect, but every single OCI item will be net of tax. The analysis shows that 25 entities (40% of the sample) have opted for the second approach (see Figure 6). In most cases, the specific tax entry has been collocated just before the total OCI amount, but in some rare cases, it has also been positioned in the midst of the items included in OCI. The other 37 entities (60% of the sample) have chosen to record the OCI components already net of tax. Concluding Remarks This study has examined a sample of Italian listed corporate groups, in order to verify the compliance of the CI statement format with IAS 1 revised in 2007. With respect to the main innovation introduced by the 2007 revision of IAS 1, the results show that a large majority (90%) have opted to present two separate income statements. This choice could be explained by several factors. First of all, such a solution is more familiar with the accounting format used hitherto in Italy. Secondly, it is consistent with the typical measurement basis of Italian accounting doctrine based on the historical cost system, hence with NI. Moreover, this option is justified by preparers stating that it facilitates comparisons with non-IFRS national competitors (Ferraro, 2011). Finally, although not investigated by this study, it is worth remembering the findings of some empirical surveys previously analyzed. In particular, such studies have pointed out the tendency by entities to reduce the importance of CI as measure of performance by not adopting the single statement of CI: (1) when entities recognize negative OCI; (2) for hiding the volatility of OCI; and (3) for making it more difficult for users to uncover evidence of earnings management. With reference to the denominations assigned to the income statements, the most interesting result is related to the fact that 84% of those entities adopting the two-statement approach have used simply the term “income statement” rather than separate income statements. It could be considered only as a matter of labels, but the use of such a name could implicitly underline that most Italian entities give more weight to traditional NI, believing that it is the “true” income for measuring the performance. The number of items and subtotals presented in the statement of CI and the different types of intermediate margins used show a high diversity in accounting practice. As regards the classification of expenses, 89% of the entities belonging to the sample have preferred the presentation of expenses by nature, while only 11% of the sample has adopted the presentation of expenses by function. Taken into account the fact that the study by Devalle (2010) shows how in average about 50% of European companies have chosen the classification by nature and the other 50% by function, this result reflects again the strong link with the Italian accounting tradition. In fact, it is worth observing that the previous practice before the introduction of IFRS is dictated by Civil Code, which requires the classification by nature. Moreover, no entity has presented the operating expenses exclusively in the notes as allowed by IAS 1. With reference to the presentation of OCI, 77% of the sample has highlighted the total OCI amount (even if not required at the time of the presentation of such reports), showing a choice geared to transparency and adopting ahead a requirement introduced only by the amendments to IAS 1 in June 2011. Instead, the option between the presentation of OCI items before or after the taxes effects does not show uniformity in accounting

 

18

COMPREHENSIVE INCOME STATEMENT’S COMPLIANCE WITH IAS 1

practice. In summary, the findings emerging from this work show some quite clear evidences. On the one hand, the number of line items and the number and the type of intermediate results presented in the sampled entities signify a high degree of heterogeneity of financial information, which decreases the comparability across entities, highlighting the urgent need to complete the joint project of the standards setters (IASB and FASB) on financial statement presentation. In fact, the goal of this project is to improve the comparability and understandability of financial statements by imposing a greater degree of standardization in the format, setting a meaningful model of disaggregation with some mandatory key line items. On the other side, the choice of certain alternatives by most of the sampled entities (the two-statement approach, some denominations used for the income statements, and the classification by nature) is likely to be influenced by the Italian accounting tradition, which could nevertheless hamper the comparability across countries and the international financial reporting convergence (Ding, Jeanjean, & Stolowy, 2005; Delvaille, Ebbers, & Saccon, 2005).

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