Usefulness of Comprehensive Income Reporting in Canada

Abstract

In March 2003, the Canadian Accounting Standard Board (AcSB) issued an Exposure Draft (ED) proposing a new Handbook Section 1530, COMPREHENSIVE INCOME(along with two other related new standards on FINANCIAL INSTRUMENTS-RECOGNITION AND MEASUREMENT, and HEDGES). These proposed standards are partly motivated partially by the need to recognize the change in the fair value of certain financial instruments as other comprehensive income and partially to harmonize the accounting standards between the US and Canada. The objective of this paper is to examine the incremental information content of the components of the other comprehensive income over net income and the relative predictive power of comprehensive income vis-a-vis net income, using a sample of crosslisted Canadian firms in the period of 1998 to 2003 (listed in the U.S.), which already report other comprehensive items in accordance with SFAS 130. Since the exposure draft on comprehensive income issued by the AcSB states that it aims to harmonize the accounting standards between the US and Canada, we expand our sample to include the entire sample of US firms to investigate the usefulness of disclosing components of other comprehensive income in the post-adoption periods of the SFAS130 (1998 - 2003) and compare it with the pre adoption period (1994-1997), using the COMPUSTAT database. In addition, we re-examine the association between market returns and the components of other comprehensive income for a sub-sample of firms obtained from the Mergent Online database, to examine the change in the fair value of cash flow hedges for the period from 1999 to 2003. In contrast to the results documented by Dhaliwal et al. (1999) of no significant association between the components other comprehensive income and stock returns, we provide evidence that each of the components of other comprehensive income are associated with market returns. This association is stronger for the post-adoption period of SFAS 130 than for the pre-adoption period. The results also hold for non-financial institutions. We observe, however, that net income is a better predictor of future net income/comprehensive income/cash flows from operations than comprehensive income. The results for the reduced sample using the Mergent database with cash flow hedges indicate that the market reacts positively for firms' cash flow hedges. These results also hold (except for foreign currency translation adjustment) for a sub-sample of Canadian cross-listed firms. Overall, our findings suggest that requiring Canadian firms to disclose other comprehensive income components is likely to improve the usefulness of accounting information. These findings, therefore, are of interest to the accounting standard setters in Canada.