January 2023
Top tutor Tom Clendon tackles a subject that many students struggle with in the exam hall.
Question
Why do gains and losses sometimes appear in the Profit or Loss account (P&L), but other gains and losses are recognised in equity and included in Other Comprehensive Income (OCI)?
Answer
Whether the gain or loss appears in the P&L or is reported directly in equity and included in OCI is a matter determined by individual accounting standards. It is a rules-based approach.
The default is, however, that gains & losses appear in the P&L.
The following accounting standards require that certain gains and losses are recognised in equity and reported in OCI.
• IAS16 Property Plant & Equipment and revaluation gains and losses: But the devil is in the detail! This is because sometimes revaluation gains and losses are recognised in P&L. Revaluation gains are in recognised in equity, unless they are a reversal of a loss previously recognised in P&L. And revaluation losses are recognised in equity only if they can be offset against previous gains relating to the same asset.
• IAS 21 Foreign Currency and the group exchange differences arising on the retranslation of an overseas subsidiary: However, it’s worth noting that foreign exchange differences at the individual company stage are recognised in P&L.
• IAS 19 Employee Benefits and the remeasurement gain or loss that arises on defined benefit pension schemes.
• IFRS 9 Financial Instruments and the gains or losses on financial assets designated as Fair Value Through OCI.
• IFRS 9 Financial Instruments and the gain or loss on derivatives designated as a cash flow hedge (to the extent they are effective).
Observation and conclusion
I observe that the above gains and losses recognised directly in equity and reported in OCI tend to be:
• unrealised
• not from operating activities, and
• non-recurring in nature
Thus, the exclusion of these gains and losses from the P&L results in reported profits being more representative of underlying earnings than would otherwise be the case. This means when it comes to taking historic profits reported in P&L and extrapolating them into the future, the reported profits are relatively more predictable (and therefore more relevant).
However, having excluded such gains and losses from the P&L it means that the P&L is an incomplete record of gains and losses recognised in the period. This is addressed by including those gains and losses excluded from P&L and presenting them in OCI. In this way a total comprehensive income figure is reported. This figure is the aggregate of the P&L and OCI and so is all gains & losses recognised in the reporting period. Thus, users are presented with a complete picture (which therefore ensures a faithful representation).
And everyone wants information to be presented in a way that is relevant and a faithful representation; after all, that is what ensures that that information is useful to the users of the financial statements.
• Tom Clendon is an online ACCA SBR lecturer and podcaster – see www.tomclendon.co.uk. If you have a question for Tom WhatsApp him on 07725 350793
