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Inflection Point Investing LLC is a Registered Investment Advisory firm in New York City.
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  • O.C.I., The Income Statement "Nobody on Wall Street Knows About" 0 comments
    Oct 3, 2009 9:50 AM
    “Class, there is this second income statement called “Other Comprehensive Income” or O.C.I. that public companies use, that is usually placed deep in the 10–K, that could impact reported earnings, and that most on Wall Street were unaware of.” After hearing this statement, I could not believe what I had just heard. Here I was, in my Financial Accounting class in the Executive MBA program at the Stern School of Business, and my accounting professor, Eli Bartov, was lecturing on the topic of O.C.I. Professor Bartov, who has served in the past as an expert witness in financial accounting cases, emphasized that if “changes in O.C.I. were large enough, then true earnings may vary considerably from reported earnings.”


    Many questions immediately raced through my mind. They included:


    ·         What is O.C.I. and why is it important?
    ·         Wouldn’t changes in O.C.I. eventually appear on the regular income statement at some point?
    ·         Where is O.C.I. found?
    ·         Why wouldn’t companies simply include changes in O.C.I. with the regular income statement?

     
    These questions were all eventually answered in class and I thought it would be helpful if I summarized them below:

    The O.C.I. statement or “Other Comprehensive Income” statement is a second income statement that includes changes in the fair values of assets a company holds (in other words, unrealized gains or losses) or changes in liabilities that a company is responsible for. These assets or liabilities are not usually assets like buildings or land, but instead are securities, derivative contracts, pension liabilities, and foreign operation assets. Ultimately, the gains or losses on these assets and liabilities, when realized, do eventually make their way to the “regular” income statement; however in the interim, their changes are reflected on the Comprehensive Income Statement, often deep in the 10-K. Looked at from this perspective, the C.I. statement is important because “true” earnings may be substantially higher or lower than a company has reported.


    According to Professor Bartov, there are three ways that public companies can report O.C.I. The first, which seems to be the most logical place to put it but is rarely done, is to include it in the “regular” income statement. The second is to report it on a second statement. The third, which is the most common way for companies to report O.C.I., is by putting it in a statement of “Changes in Shareholder Equity.” Companies have “large discretion of where to put” the O.C.I. statement according to Professor Bartov.


    Eventually, these changes in O.C.I. would make their way to the regular income statement but that would not happen until the company sold the asset, closed the derivative position, or recognized the liability. This could mean a larger change in earnings down the road than the smaller change that could have occurred had it been placed in the income statement at the start. One possible reason that companies do not include O.C.I. in their regular income statement is because they may feel that these “outside” operations are not part of their continuous operations and since “unrealized” may confuse investors. Professor Bartov offered other reasons saying that “O.C.I. may increase substantially earnings volatility and or show losses that could substantially reduce the reported earnings.”
     
    To recap, the importance of O.C.I. cannot be understated. For analysts, investors, and traders to understand the “true” earnings power of a publicly traded company, they should analyze the effects that O.C.I. has on total comprehensive income. And perhaps most importantly, they should then consider whether O.C.I., if substantial, will affect Total Comprehensive income in the same way in the future.


    Special thanks to my Financial Accounting Professor Eli Bartov Professor of Accounting at the NYU Stern School of Business, for the guidance in writing this article.


    There are no disclosures to make.


    Authored by Tom Henderson, Strategist at JBH Capital.
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