What is the Best Measure of Financial Performance?

Comprehensive Income versus Net Income: Evidence from Turkey

Volkan Demir, Oğuzhan Bahadır, Aslı Gül Öncel

Department of Business Administration, Galatasaray University, Istanbul, Turkey

ABSTRACT Based on the claim that comprehensive income is a better measure of financial performance

than net income, International Accounting Standard No. 1 (IAS 1) requires that companies report comprehensive

income in a primary financial statement. In this paper, we test the ability of comprehensive income and net

income in terms of performance measurement by comparing their association with stock returns, operating cash

flows and market value of equity. Our results provide evidence on superiority of comprehensive income to net

income in terms of performance measurement. Hence, this study finds that the claim of IAS 1 is supported in

practice. On the other hand, we also examine which components improve comprehensive income’s ability to

summarize firm performance. Our results indicate that only “changes in revaluation surplus adjustment”

improves the association between comprehensive income and stock returns. This implies that investors value

comprehensive income, but that there is no benefit in reporting the separate components of comprehensive

income, except revaluations surplus adjustment.

Key Words: net income, comprehensive income, components of comprehensive income, financial performance,

IAS 1, usefulness of financial information


This paper has been financially supported by Galatasaray University Research Fund.

Correspondence Address: Galatasaray University, Çırağan Caddesi, No: 36, Beşiktaş, İstanbul, Turkey; Tel:
+90 0212 227 44 80; Fax: +90 0212 327 44 95; e-mail: vdemir@gsu.edu.tr

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1. Introduction

In April 2004, the International Accounting Standards Board (IASB) and the Financial Accounting

Standards Board (FASB) decided to work on financial statement presentation as a joint project to develop a high

quality standard for presentation of financial information. The goal of the project is to create a common standard

for the form, content, classification, aggregation and display of line items on the face of financial statements.

Phase A of the project addressed a complete set of financial statements and requirements to present comparative

information. This phase was completed with the issuance of a revised version of International Accounting

Standard No. 1 ―Presentation of Financial Statements‖ (IAS 1) in September 2007. New version of IAS 1 which

requires companies report comprehensive income in a primary financial statement brought financial statement

presentation issues largely in line with Statement of Financial Accounting Standard No.130 ―Reporting

Comprehensive Income‖ (SFAS 130). Phase B of the project which is currently in progress addresses more

fundamental issues for presentation and display of information in the financial statements. In October 2008, as a

part of this phase, the boards jointly published a discussion paper, Preliminary Views on Financial Statements in

which they proposed eliminating alternative presentation formats for comprehensive income and to require

companies present comprehensive income and its components in a single statement. Accordingly, in May 2010,

IASB issued an Exposure Draft that requires presenting a single statement of profit or loss and other

comprehensive income containing two distinct sections-profit or loss and items of comprehensive income (IASB,

ED/2010/5, BC 7).

The implementation of comprehensive income by IASB was the beginning of a new era in accounting

theory which now accepts that income does not necessarily depend on the sales of assets but rather on a

continuous process of production and distribution as well as on price changes (Coelho and Carvalho, 2007, p.

117). Comprehensive income is defined 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 (IAS

1, paragraph 7). It includes all changes in equity during a period except those resulting from investments by

owners and distributions to owners. Increasing importance of reporting comprehensive income as a measure of

firm performance may be attributed to the intended full implementation of asset and liability view and the

resulting change in the definition of performance. Originally, IFRS Framework, adopted profit (net income) as a

measure of firm performance (IASB, Framework, paragraph 69). This reflects revenue and expense view under

which periodic profit is a measure of an entity’s effectiveness in using inputs to obtain and sell output (Robinson,

1991, p.110). Profit was supposed to serve as an indicator of an entity’s usual, normal, or extended performance,

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i.e. as a direct predictor of future cash flows. Percentage of completion method of IAS 11 which requires

recognition of revenue and expenses in profit or loss in the accounting periods in which the work is performed is

an example of the implementation of revenue and expense view in IFRS (IAS 11, paragraph 26). However, it

was basically a matter of judgment how to allocate costs to the accounting periods in order to match them with

the related revenues and to avoid distortions of periodic profits (IFRS Teaching and Research Session IAAER,

p.10). Therefore, The Exposure Draft for an Improved Conceptual Framework suggests a changed meaning of

performance that rather conforms to the asset and liability view. As stated in ED for an Improved Conceptual

Framework, an entity’s financial performance provides information about the return it has produced on its

economic resources (IASB, ED/2008/5, OB 19). According to this new understanding of performance, all

changes in resources and obligations- all non-owner changes in equity-are regarded as relevant for the prediction

of future cash flows and therefore included in comprehensive income.

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 IASB’s rational for issuing new version of IAS 1 is driven by the belief that comprehensive income provides

more relevant accounting information on financial performance than net income does. Hence, the objective of

this paper is to examine whether reporting comprehensive income in a primary financial statement have value

relevance over reporting traditional net income alone. Previous empirical studies provided mixed evidence on the

performance measurement ability of comprehensive income and its components. For example, Dhaliwal et al.

(1999) report no evidence that comprehensive income disclosure required by SFAS 130 is more strongly

associated with returns than with net income. Plenborg (1996) reports that comprehensive income information is

considered value relevant by investors, but net income seems to be relatively more informative. In contrast,

Chambers et al. (2007) find evidence on the association between comprehensive income and stock returns for the

period after the implementation of SFAS 130. Similarly, Biddle and Choi (2006) find some evidence confirming

that comprehensive income dominates net income in explaining equity returns and that the disclosure of

comprehensive income components is useful. Our empirical analysis provides evidence that comprehensive

income is superior to net income in terms of performance measurement.

Our study builds upon the study by Dhaliwal et al. (1999). However, it is different from Dhaliwal et al.

(1999) in that we include price model in addition to stock return and operating cash flows model used by

Dhaliwal et al. (1999). The combined use of both price and return models may provide more convincing

evidence on the value relevance of comprehensive income and net income (Kothari and Zimmerman, 1995).

We use a sample of listed Turkish firms in the period of 2005-2008, which present IFRS based financial

statements since 2005. Although many studies were conducted after the implementation of SFAS 130 (see Smith

and Reither 1996, Bhamornsiri and Wiggins 2001, Maines and McDaniel 2000, Dhaliwal et al. 1999, Chambers

et al. 2007, Lee et al. 2006) empirical evidence on the implementation of IAS 1 is limited. This study, therefore,

may contribute to the literature by providing empirical evidence on the effectiveness of IAS 1.

The rest of the paper is organized as follows. Section 2 explains theoretical background of the concept of

comprehensive income and discusses prior literature on the performance measurement ability of comprehensive

income and net income. Section 3 describes the sample selection, data and research design. Section 4 presents

empirical tests and Section 5 summarizes results.

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2. Theoretical Background and Literature Review

This section reviews literature survey related to the effects of presentation format of comprehensive income

on financial performance and comparison of performance measuring ability of traditional net income and that of

comprehensive income. It also explains theoretical background of reporting comprehensive income.

2.1. Theoretical Background

The major goal of financial reporting is to provide information about the financial position, financial

performance and cash flows of an entity that is useful to a wide range of users in making economic decisions

(IAS 1, paragraph 9; Cooper, p.3). Under a strong form of market efficiency where all information is available,

displaying accounting information is irrelevant to economic decisions. In a semi-strong or weak form of

efficiency, however, issues of presenting accounting information, including the way that financial performance is

expressed, become important (Van Cauwenberge and De Beelde, 2007). Financial performance is usually

expressed in terms of income measures, such as net income, operating income and comprehensive income.

Clearly, none of these measures can capture all aspects of economic activity and be suited by itself to the

evaluation of financial performance (Cooper, 2007, p.5).

The debate of which income measure best represents the firm performance has its roots in different income

definitions. Under the concept of capital maintenance (or asset and liability view of financial performance),

income is measured as the difference of capital (net assets) at the beginning and end of a given year, excluding

transactions with owners (Ramond et al. 2007, p.131; Okada 2008, p.78). The concept of capital maintenance

gives rise to comprehensive income which requires that all changes in value of assets and liabilities be reported

in income statement.

According to some authors, reporting comprehensive income has many advantages. For example, Robinson

(1991) argues that reporting comprehensive income will give financial statement users all of the data they need

to evaluate which net income item is most important. Hence financial statements which display comprehensive

income, more effectively satisfy the demands of financial statement users and give much more relevant

information needed to evaluate firm performance (Robinson, 1991; Keating, 1999). However, opponents of

comprehensive income reporting present a number of counter arguments. Firstly they argue that other

comprehensive income items are transitory in nature and thus not representative of core earnings. Therefore, they

cannot be used in predicting future cash flows of the firm. Secondly they argue that including other

comprehensive income items in reported income makes it more difficult to forecast earnings. And finally, since

other comprehensive income items consist of unrealized holding gains and losses which are driven by market-

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wide factors over which managers have no control; it is argued that they should not be used in evaluating

managerial performance. (Chambers et al., 2007)

Comprehensive income proposed by new version of IAS 1 contains net income and also fair value

adjustments resulted from fair value measurements of certain assets and liabilities (other comprehensive income

items). The standard allows firms two options in reporting comprehensive income. Firms may present all items

of income and expense in a single statement (a statement of comprehensive income) or in two statements (a

separate income statement and statement of comprehensive income). When ―single statement approach‖ is

adopted, companies combine current content of income statement with other comprehensive income items.

Under ―two-statement approach‖, companies present a statement displaying components of profit or loss

(separate income statement) and a second statement beginning with profit or loss and displaying components of

other comprehensive income (statement of comprehensive income) (IAS 1, paragraph 81). Other comprehensive

income items that were reported previously direct adjustments to equity are now reported as adjustments to ―net

income‖ to arrive at comprehensive income. Other comprehensive income items of IAS 1 include the following:

 changes in revaluation surplus (IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets)

 actuarial gains and losses on defined benefit plans recognized in accordance with IAS 19 Employee

Benefits

 gains and losses arising from translating the financial statements of a foreign operation (IAS 21 The

Effects of Changes in Foreign Exchange Rates)

 gains and losses on remeasuring available-for-sale financial assets (IAS 39 Financial Instruments:

Recognition and Measurement)

 the effective portion of gains and losses on hedging instruments in a cash flow hedge (IAS 39 Financial

Instruments: Recognition and Measurement)

2.2. Literature Review

The academic debate concerned with usefulness of comprehensive income information began after the

issuance of SFAS 130 in the United States. SFAS 130 allows firms to present comprehensive income in either a

statement of comprehensive income or a statement of stockholders’ equity. Bhamornsiri and Wiggins (2001)

examine financial statements of S&P 100 companies between 1997 and 1999 and find that the majority of firms

chose to report comprehensive income in the equity section of the balance sheet rather than in a separate

financial statement. Their findings also indicate that comprehensive income disclosures are not associated with

the positive or negative character of comprehensive income. Thus there is no evidence to support the

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manipulation of comprehensive income disclosures. However, evidence produced by the research of Maines and

McDaniel (2000) is somewhat different. Using an experimental method, Maines and McDaniel (2000) examine

whether / how alternative presentation formats for comprehensive income affects nonprofessional investors’

judgments of financial performance of companies. Their results show that the way in which nonprofessional

investors process comprehensive income information changes only when it is reported in income statements.

Similar results are obtained by Smith and Reither (1996). Before the implementation of SFAS 130, Smith and

Reither (1996) adjusted the net income of the top 10 companies from seven industries chosen from the Fortune

1,000 industry listing for other comprehensive income items. The recast financial information shows that when

comprehensive income items are reported in the income statement instead of in the equity section of the balance

sheet, comparison within and among industries becomes more meaningful and easy.

In other study, Plenborg (1996) examines usefulness of comprehensive income numbers for a sample of

Danish stock market from 1985 to 1992 and compares results with the US market. Results show that

comprehensive income information is considered value relevant by investors, but net income seems to be

relatively more informative (Plenborg, 1996, p. 189). Therefore, Plenborg (1996) concludes that comprehensive

income is not a better measure of firm performance in Denmark. Similarly, Dhaliwal et al. (1999) investigate the

effect of reporting traditional net income, comprehensive income in a broader sense (which includes three items

of comprehensive income under the concept of SFAS 130 as well as several non-SFAS 130 items) and

comprehensive income of SFAS 130 on stock returns. They used a sample consisting of all firms contained in

COMPUSTAT and CRSP data for 1994 and 1995. They found no evidence that comprehensive income is more

strongly associated with returns than with net income. Their results also indicate that within the ―other

comprehensive income‖ components of SFAS 130, only marketable securities adjustment improves the

association between income and stock returns.

After the implementation of SFAS 130, academic researches accelerated. However, like the results of

previous researches, evidence related to the explanatory power of comprehensive income is mixed. Cahan et al.

(2000) investigate market-based evidence on the usefulness of comprehensive income disclosures in a statement

of changes in equity. They find that comprehensive income is more value relevant than net income and that

revaluation surplus adjustment and foreign currency translation adjustment do not have incremental value

relevance beyond comprehensive income. Dehning and Ratliff (2004) examine data from firms before and after

the implementation of SFAS 130. Their results indicate that there is no clear evidence that income reported on a

comprehensive basis is a better measure than net income. Following a similar methodology, Chambers et al.

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(2007) find evidence on the association between comprehensive income and stock returns for the period after the

implementation of SFAS 130. Their results also suggest that investors pay greater attention to other

comprehensive income information reported in the statement of changes in equity, rather than in a statement of

financial performance. Biddle and Choi (2006) examine predictive ability of net income, comprehensive income

defined by FASB, fully comprehensive income (including all adjustments to equity) and comprehensive income

components by using firm-year observations with required Compustat and CRSP data from the period 1994-98.

Their results reveal that comprehensive income is superior to net income and fully comprehensive income in

explaining equity returns. Lee et al. (2006) investigate the effect of accounting choice of management on the

reporting format of comprehensive income using a sample of 82 publicly traded property-liability insurers in

1998, the year in which SFAS No. 130 was implemented. They provide evidence that insurers who have an

accounting policy of managing earnings through realized securities’ gains and losses are more likely to report

comprehensive income in a statement of equity than in a performance statement that is a single income

statement. Similar to the research of Lee et al. (2006), Bamber et al. (2010) investigated the motivation of

managers behind the decision of reporting comprehensive income in a separate comprehensive income statement

or in the equity section of a balance sheet. Their results indicate that managers with stronger equity-based

incentives and less job security are significantly less likely to use performance reporting.

The mixed evidence in the literature may be attributed partially to the use of ―as if methodology‖ to

construct an ex-ante measure of other comprehensive income prior to the implementation of SFAS 130, which

introduces measurement error (Kanagaretnam et al. 2009). To eliminate this measurement error, Kanagaretnam

et al. (2009) use actual data on other comprehensive income for a sample of Canadian firms cross-listed in the

US in the period 1998–2003. They find that comprehensive income is more strongly associated with both stock

price and returns compared to net income. Moreover, available-for-sale and cash flow hedges components of

comprehensive income are significantly associated with price and market returns. However, their results also

indicate that aggregate comprehensive income is more strongly associated (in terms of explanatory power) with

both stock price and returns compared to net income. In this study, we use ―as if methodology‖ because IAS 1

was not required in annual reports until the end of the year 2009. Thus, the post-IAS 1 time-series is not long

enough to conduct the proposed tests. For our research, we use a sample of listed firms from Turkey for the

period 2005-2008. We start the sample period by 2005 because these companies have been presenting their

financial statements in accordance with IFRS since the fiscal year beginning after 1 January 2005.

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 This study, like previous researches, addresses performance measurement ability of income summary

measures. Most of the previous researches (Dhaliwal et al. 1999; Cahan et al. 2000; Dehning and Ratliff 2004;

Chambers et al. 2007) evaluate the relative ability of comprehensive income and net income to summarize firm

performance as reflected in stock returns. As discussed by Skinner (1999) and Dechow (1994), this approach

assumes that stock markets are efficient in the sense that they reflect quickly and in an unbiased way all publicly

available information on firm performance (Skinner 1999; Dechow 1994). One way of addressing this issue is to

use another measure, such as operating cash flows or earnings, instead of stock returns (Skinner 1999). For this

reason, we test the association between income summary measures and operating cash flows. Moreover, the

combined use of both price and return models potentially provide more convincing evidence on the value

relevance of comprehensive income and net income (Kothari and Zimmerman, 1995). Therefore, we include into

the study the price model in addition to stock return and operating cash flows model.

For studying the measurement ability of income summary measures, we test the following hypotheses:

H1: The association between returns and comprehensive income is stronger than that of net income.

H2: The association between comprehensive income and operating cash flows is stronger than that of net

income.

H3: The association between stock market price and comprehensive income is stronger than that of net

income.

3. Sample and Research Design

The sample used to estimate the effects of comprehensive income and net income on firm performance

consists of the firms included in ISE (Istanbul Stock Exchange) national index. We studied firms listed in ISE

because these companies have been presenting their financial statements in accordance with IFRS since the fiscal

year beginning after 1 January 2005. The other reason to study firms listed in ISE is the frequency of other

comprehensive income items adjustments. The initial sample comprised 1.287 firm-year observations. After

deleting firm-years with missing income and stock returns data, 864 firm-year observations remain: 206

observations from 2005, 214 from 2006, 227 from 2007 and 217 from 2008.

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Table 1: Sample of Companies listed in ISE (2005-2008)

Year 2005 Year 2006 Year 2007 Year 2008 Total Sample
Industry groups Num. % Num. % Num. % Num. % Num. %
Manufacturing Industry 126 61,17% 130 60,75% 130 57,27% 124 57,14% 510 59,03%
Financial Institutions 45 21,84% 47 21,96% 57 25,11% 56 25,81% 205 23,73%
Wholesale and Retail
Trade, Hotels and
Restaurants 11 5,34% 13 6,07% 13 5,73% 14 6,45% 51 5,90%
3
Others 24 11,65% 24 11,22% 27 11,89% 23 10,60% 98 11,34%
Total 206 100% 214 100% 227 100% 217 100% 864 100%

We gathered data on stock returns, market value of equity and common shares outstanding from ISE website

and all other accounting data from the annual reports. Since reporting comprehensive income is not required

until 2009, we prepare a statement of comprehensive income on a pro forma basis using numbers gathered from

various places in the financial statements. We arrive at comprehensive income by adjusting net income with

other comprehensive income components: (Comprehensive income = Net income +/ — changes in revaluation

surplus +/— actuarial gains and losses on defined benefit plans +/— gains and losses arising from translating the

financial statements of a foreign operation +/— gains and losses on remeasuring available-for-sale financial

assets +/— the effective portion of gains and losses on hedging instruments in a cash flow hedge).

3
Since the number of observation in other sectors is insufficient, we present their results together under the heading of
―others‖.

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Table 2: Descriptive statistics (864 observations)

Year 2005 2006 2007 2008

Variable Mean Std. Dev. Mean Std. Dev. Std. Dev. Std. Dev. Mean Std. Dev.
R 84 99 -1 49 32 35 -5 56
NI 43938618 282000000 125000000 97892901 349000000 344000000 125000000 344000000
CI 59607250 262000000 73407834 89153562 349000000 179000000 130000000 360000000
OCF 149000000 938000000 91979244 284000000 1180000000 591000000 124000000 634000000
MVE 834000000 2190000000 782000000 698000000 2230000000 1990000000 1350000000 3730000000
CIRV-ADJ, t 1158950 8328882 165679,74 5521597,16 2109520 15880644 1697713 42035917
CIAG-ADJ, t 0 0 0 0 0 0 0 0
CIFC-ADJ, t 469679 5401352 5182466 22727466 3158610,84 13873573 5182466 22727466
CIAFS-ADJ, t 14833585 104139842 2580457 47635735 6303619,00 53357775 13508572 135101868
CIHI-ADJ, t 145774 1464223 194615 3149187 118548,467 1697954 -2110945 13854401

R = One year buy and hold return

NI = Traditional net income (including all revenues or gains and correlated expenses or losses)
CI = Comprehensive income of IAS 1 (including in addition to traditional net income, changes in revaluation surplus in accordance with IAS 16 Property, Plant and
Equipment and IAS 38 Intangible Assets, actuarial gains and losses defined benefit plans recognized in accordance with IAS 19 Employee Benefits, gains and losses arising
from translating the financial statements of a foreign operation in accordance with IAS 21 The Effects of Changes in Foreign Exchange Rates, gains and losses on re-
measuring available-for-sale financial assets in accordance with IAS 39 Financial Instruments: Recognition and Measurement and the effective portion of gains and losses on
hedging instruments in a cash flow hedge in accordance with IAS 39 Financial Instruments: Recognition and Measurement)
OCF: Operating cash flows
MVE: Market value of equity (price per share times number of shares outstanding)
CIRV-ADJ, t = net income adjusted for changes in revaluation surplus
CIAG-ADJ, t = net income adjusted for actuarial gains and losses on defined benefit plans
CIFC-ADJ, t = net income adjusted for gains and losses from translating financial statements of a foreign operation
CIAFS-ADJ, t = net income adjusted for re-measuring available-for-sale financial assets
CIHI-ADJ, t = net income adjusted for effective portion of gains and losses on hedging instruments in a cash flow hedge

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Table 2 reports descriptive data for the sample used to estimate return and price models. Due to lack of missing
data in CIAG-ADJ, t (net income adjusted for actuarial gains and losses on defined benefit plans), the value of the
mean and standard deviation are equal to zero. As we can observe from the results, there is no clear evidence
between the mean and standard deviation values of net income and comprehensive income.

4. Empirical Analysis

4.1. Tests of the Association of Alternate Measures of Income with Stock Returns (H1)

As discussed in the literature review section, the empirical evidence on the value relevance of

comprehensive income relative to net income is mixed. Dhaliwal et al. (1999) report no evidence on the

superiority of comprehensive income to net income in terms of performance measurement. Similarly, Plenborg

(1996) and Dehning and Ratliff (2004) find evidence that net income is more value-relevant than comprehensive

income. Using actual numbers, Kanagaretnam et al. (2009), Biddle and Choi (2006) and Cahan et al. (2000),

however, document results that contradict Dhaliwal et al. (1999). Using a sample of Turkish listed firms, we re-

examine this issue to provide further insights.

We tested the performance measurement ability of net income and that of comprehensive income by

following approaches adopted in previous researches (Dhaliwal et al., 1999; Dehning and Ratliff, 2004). We

regressed stock returns on net income and comprehensive income to see which measure is more highly

associated with returns:

Rt = α0 + β1 * NIt + εt (Model 1a)

Rt = α0 + β1 * CIt + εt (Model 1b)

To investigate whether reporting comprehensive income is different at industries level, we estimate the
models for industrial groups. For this purpose, the analyze starts with grouping data on sectors. The effect of net
income and comprehensive income on stock returns for different sectors is then examined by using two
regression models applied to a sample consisting of 864 firm-years data for the period between 2005 and 2008.
Table 3 presents the results of the tests of the value relevance of comprehensive income and net income using a
stock returns model. As shown in the table, F statistics of the estimated models at total sample level are
significant. Adjusted R2 for the model 1 and 2 are 0,423 and 0,547, respectively. P-values of the coefficients of
the two models are significant. The adjusted R 2 using comprehensive income and net income at the 0, 05 two-
tailed levels are very close on the total sample and also on different sectors for the period analyzed. This implies
that net income and comprehensive income are not very different from each other in explaining stock returns.
2
The adjusted R of comprehensive income, however, is greater than that of net income indicating that the
association between comprehensive income and stock returns is stronger than the association between net
income and stock returns. Hence, the results indicate that comprehensive income has better association with
performance than net income.

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Table 3: Results of the regression of comprehensive income and net income values

Model 1(a) (Net Income) Model 1 (b) (CI)

Industry Groups
Adj. R2 P-value Adj. R2 P-value
Total Sample 0,423 0,0069 0,547 0,0088

Manufacturing Industry 0,321 0,0045 0,425 0,0021

Financial Institutions 0,355 0,0032 0,386 0,0075

Wholesale and Retail Trade, 0,568 0,0065 0,442 0,0078

Hotels and Restaurants
Others 0,627 0,0072 0,612 0,0014

Since IAS 1 does not allow recognizing changes in value of all assets in comprehensive income, it is

criticized being not to meet the definition of net income under capital maintenance approach which states that

―net income is the difference between the capital at the beginning and end of a given year, excluding transactions

with owners, such as investments made and distributed‖. Furthermore, IAS 1 does not specify a criteria for

distinguishing items that should be reported in ―profit or loss‖ from items that should be included in ―other

comprehensive income‖ (Mechelli, 2008). To gain further intuition on the value relevance of other

comprehensive income and to identify the appropriateness of comprehensive income items, we need to examine

which items improve comprehensive income’s ability to summarize firm performance. Following Dhaliwal et al.

(1999) and Biddle and Choi (2006), we estimate the following model to examine the association between the

other comprehensive income items and stock returns:

Rt = α0 + β1 * CIRV-ADJ, t + εt IAS 16/IAS 38-ADJ,t (Model 1c)

Rt = α0 + β1 * CIAG-ADJ, t + εt IAS 19 -ADJ,t (Model 1d)

Rt = α0 + β1 * CIFC-ADJ, t + εt IAS 21 -ADJ,t (Model 1e)

Rt = α0 + β1 * CIAFS-ADJ, t + εt IAS 39*-ADJ,t (Model 1f)

Rt = α0 + β1 * CIHI-ADJ, t + εt IAS 39**-ADJ,t (Model 1g)

CIRV-ADJ, t = net income adjusted for changes in revaluation surplus

CIAG-ADJ, t = net income adjusted for actuarial gains and losses on defined benefit plans

CIFC-ADJ, t = net income adjusted for gains and losses from translating financial statements of a foreign operation

CIAFS-ADJ, t = net income adjusted for re-measuring available-for-sale financial assets

CIHI-ADJ, t = net income adjusted for effective portion of gains and losses on hedging instruments in a cash flow

hedge

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 Like the value relevance of comprehensive income, there is also mixed evidence related to the components

of comprehensive income. For example, Barth (1994) investigated how disclosed fair value estimates of banks’

investment securities and securities gains and losses based on those estimates are reflected in stock prices in

comparison with historical costs. Their results indicate that fair value adjustments provide significant

explanatory power of stock prices. Similarly, Dhaliwal et al. (1999) provide empirical evidence on that only

marketable adjustment improves the association between comprehensive income and stock returns.

Kanagaretnam et al. (2009) conducted an empirical study by employing actual data for a sample of Canadian

firms cross-listed in the US. They find that available-for-sale and cash flow hedges components of

comprehensive income are significantly associated with price and market returns. Cahan et al. (2000) provide

empirical evidence on that other comprehensive income components, except revaluation surplus adjustment and

foreign currency translation adjustments, improve the association between comprehensive income and stock

returns. They conclude that ―…this implies that investors value comprehensive income, but that there is no

benefit in reporting the separate components of comprehensive income, at least for revaluations of fixed assets

and foreign currency translation adjustments‖ (Cahan et al., 2000).

The results of estimating models 1(c) to 1 (g) are reported in Table 4. In the full sample, we find that

―changes in revaluation surplus adjustment‖ is the only component of IAS 1 ―other comprehensive income‖ that

improves the association between income and stock returns. An examination of within- industry results indicates

that this finding is driven by Wholesale and Retail, Hotels and Restaurants sector firms. These results suggest

that, with the exception of the changes in revaluation surplus adjustment, other comprehensive income items

merely add noise to comprehensive income. That is, the inclusion of the components of other comprehensive

income does not improve the relationship with returns and therefore they are not value-relevant. Therefore, we

believe that this finding supports the idea that presenting separate components of comprehensive income in the

statement of comprehensive income is not needed.

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 Table 4: The regression of the model 1(c) to 1(g) for all components of the comprehensive income

Model 1 (c) Model 1 (d) Model 1 (e) Model 1 (f) Model 1 (g)
Industry Groups
Adj. R2 P-value Adj. R2 P-value Adj. R2 P-value Adj. R2 P-value Adj. R2 P-value
N Total Sample 0,2112 0,0020 0,1216 0,0001 0,1147 0,0000 0,1187 0,0004 0,1106 0,1135
Manufacturing Industry 0,1134 0,0011 0,1123 0,0000 0,1017 0,0000 0,1169 0,0014 0,1056 0,0000

Financial Institutions 0,1256 0,0053 0,2341 0,0002 0,1908 0,0011 0,1008 0,0069 0,1086 0,0105

Wholesale and Retail 0,3114 0,0012 01202 0,0000 0,0061 0,01466 0,0171 0,0055 0,1147 0,0314
Trade, Hotels and
Restaurants

Others 0,1012 0,0020 0,1802 0,0130 0,1202 0,0121 0,1148 0,0022 0,1172 0,0041

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4.2. Tests of the Association of Alternate Measures of Income with Future Operating Cash Flows (H2)

Evaluating performance measurement ability of income measures by using a stock return model is heavily

criticized in the literature. According to Skinner (1999) and Dechow (1994), stock return models assume that

stock markets are efficient in the sense that they reflect quickly and in an unbiased way all publicly available

information on firm performance. To address this issue operating cash flows or earnings should also be included

in regression models (Skinner 1999). Firm performance should be reflected in future operating cash flows and

income, as well as, in stock returns. Therefore, if comprehensive income is a better measure of firm performance

than net income, then it is expected that future operating cash flows are more strongly associated with

comprehensive income than with net income (Dhaliwal et al., 1999). We investigate performance measurement

ability of alternate income measures in terms of future operating cash flows by using the following regression

models:

OCFt+1 = α0 + β1 * NIt + εt (Model 2a)

OCFt+1 = α0 + β1 * CIt + εt (Model 2b)

Table 5: The regression of the model of 2(a) and 2(b)

Model 2(a) (Net Income) Model 2 (b) (CI)

Industry Groups
Adj. R2 P-value Adj. R2 P-value
Total Sample 0,2944 0,0211 0,4053 0,0013

Manufacturing Industry 0,3277 0,0122 0,3101 0,0012

Financial Institutions 0,1014 0,0251 0,3309 0,0001

Wholesale and Retail Trade, 0,2161 0,0027 0,2031 0,0009

Hotels and Restaurants
Others* 0,1901 0,0031 0,1610 0,0027

In these models, the dependent variable is operating cash flows in year t+1 for a given firm and the

independent variable is alternately net income or comprehensive income in year t for the corresponding firm.

The results of estimating the two models of this hypothesis are shown in table 5. As shown in the table, F

statistics of the estimated models at total sample level are significant. Adjusted R 2 for the model 2(a) and 2(b)

are 0,2944 and 0,4053, respectively. P-values of the coefficients of the two models are also significant. Higher

adjusted R2 for comprehensive income provide empirical evidence on that future operating cash flows are

strongly associated with comprehensive income than with net income. This finding is also inconsistent with that

of Dhaliwal et al., 1999 which find no clear evidence that comprehensive income is more strongly associated (in

terms of explanatory power) with future operating cash flows than net income.

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 To examine the association between components of other comprehensive income and operating cash flows,

we use the following models:

OCFt+1 = α0 + β1 * CIRV-ADJ, t + εt IAS 16/IAS 38-ADJ,t (Model 2c)

OCFt+1 = α0 + β1 * CIAG-ADJ, t + εt IAS 19 -ADJ,t (Model 2d)

OCFt+1 = α0 + β1 * CIFC-ADJ, t + εt IAS 21 -ADJ,t (Model 2e)

OCFt+1 = α0 + β1 *CIAFS-ADJ, t+ εt IAS 39*-ADJ,t (Model 2f)

OCFt+1 = α0 + β1 * CIHI-ADJ, t + εt IAS 39**-ADJ,t (Model 2g)

The results of estimating models 2(c) to 2 (g) are reported in Table 6. In the full sample, we find that

―changes in revaluation surplus adjustment‖ is the only component of comprehensive income that improves the

association between income and operating cash flows. Hence, our results indicate that except revaluation surplus

adjustment, components of other comprehensive income are poor predictors of future profitability due to their

transitory nature.

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 Table 6: The regression of the model 2(c) to 2(g) for all components of the comprehensive income
Model 2c Model 2d Model 2e Model 2f Model 2g
Industry Groups
Adj. R2 P-value Adj. R2 P-value Adj. R2 P-value Adj. R2 P-value Adj. R2 P-value
N Total Sample 0,3235 0,0014 0,1511 0,0013 0,2170 0.0102 0,0582 0,0044 0,3477 0,0014

Manufacturing Industry 0,0228 0,0040 0,0037 0,0014 0,0028 0,0062 0,0025 0,0481 0,0035 0,0182

Financial Institutions 0,1239 0,0021 0,0439 0.002 0,1365 0.0020 0,1239 0.0202 0,6955 0.0020

Wholesale and Retail 0,0506 0,0072 0,2310 0,0012 0,450 0,0049 0,2410 0,0222 0,4011 0,0001
Trade, Hotels and
Restaurants

Others 0,3873 0,0011 0,0121 0,0028 0,0250 0,0032 0,0546 0,0001 0,1575 0,0027

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4.3. Tests of the Association of Alternate Measures of Income with Market Value of Equity (H3)

Due to both econometric and theoretical problems with the returns model, Kothari and Zimmerman (1995)

suggest that researchers should use additional models in their empirical analysis, such as the price model, to

draw more definitive inferences (Dhaliwal et al, 1999). Inclusion of both market value and return models

potentially provide more convincing evidence. Accordingly, we also investigate the association between

alternate measures of income and stock prices by using a regression model where the dependent variable is

market value of equity and the independent variable is alternately net income and comprehensive income:

MVEt = α0 + β1 * NIt + εt (Model 3a)

MVEt = α0 + β1 * CIt + εt (Model 3b)

Table 7: The regression of the model of 3(a) and 3(b)

Model 3(a) (Net Income) Model 3(b) (CI)

Industry Groups
Adj. R2 P-value Adj. R2 P-value
Total Sample 0,5812 0,0140 0,6326 0,0015

Manufacturing Industry 0,7146 0,0157 0,6888 0,0025

Financial Institutions 0,4686 0,0004 0,5381 0,0011

Wholesale and Retail Trade, 0,4256 0,0003 0,4148 0,0002

Hotels and Restaurants

Others 0,4256 0,0024 0,6120 0,0003

The results of the estimation of the models of H3 at total sample level are shown in table 3. As shown in

Table 7, p-value of coefficient of NI for the first model, as well as, p-value of coefficient of CI for the second

model is significant. Also, F statistics of the two models are significant. Adjusted R2 for the model 3(a) and 3(b)

are 0,5812 and 0,6326, respectively. Results of model 3 (a) and model 3 (b) reveal that both net income and

aggregate comprehensive income are value-relevant in explaining price.

5. Conclusion

In this study, we compared the association between net income and stock returns with that between

comprehensive income and stock returns in order to test which income measure best summarizes firm

performance. According to our data set from 2005 to2008, we find empirical evidence that comprehensive

income is more strongly associated with stock returns, operating cash flows or market value of equity than net

income as suggested by IASB. Hence, this paper finds that the claim of IAS 1 is supported in practice.

Moreover, we also examined which comprehensive income adjustment improves the ability of income to

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summarize firm performance. Results show that only changes in revaluation surplus adjustment improves the

association between comprehensive income and stock returns. This implies that investors value comprehensive

income, but that there is no benefit in reporting the separate components of comprehensive income, except

revaluations surplus adjustment.

Our study extends the prior research (Dhaliwal et al., 1999; Cahan et al., 2000, Dehning and Ratliff, 2004,

Chambers et al., 2007) by including the price model in addition to stock return and operating cash flows model.

However, it is also important to note that due to the use of as if methodology to construct an ex-ante measure of

other comprehensive income, our results may introduce some measurement error.

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