ACCOUNTING HORIZONS American Accounting Association

Vol. 30, No. 4 DOI: 10.2308/acch-51544

December 2016
pp. 511–516

COMMENTARY

The Definitions of Net Income and Comprehensive Income

and Their Implications for Measurement
Ikuo Nishikawa
Keio University

Takao Kamiya
Ernst & Young ShinNihon LLC

Yasunobu Kawanishi
Accounting Standards Board of Japan (ASBJ)
SYNOPSIS: Historically, accounting standard-setters have not been successful in defining net income. Nor have
they been successful in justifying the use of other comprehensive income (OCI) and recycling. This paper proposes
the definitions of net income and comprehensive income and an approach to measurement based on the proposed
definitions. Net income and comprehensive income should be defined as two separate elements of financial
statements, with OCI being the linkage factor that reconciles the two elements. Recycling of all OCI items is required
for both elements to have the characteristic of all-inclusiveness. Net income should represent the irreversible
outcomes of an entity’s business activities, and it follows that the measurement basis of current value should be used
from the perspective of reporting an entity’s financial performance only when an asset (or a liability) is readily
converted to cash (or settled) and the entity’s business activity does not legally, contractually, or economically restrict
the entity’s opportunity to convert the asset to cash (or settle the liability).

INTRODUCTION
istorically, accounting standard-setters have not been successful in defining net income.1 Nor have they been

H successful in justifying the use of other comprehensive income and recycling2 in their Conceptual
Frameworks.
The current Conceptual Framework of the Financial Accounting Standards Board (FASB) defines comprehensive income
as ‘‘the change in equity of a business enterprise during a period from transactions and other events and circumstances from
non-owner sources’’ (FASB 1985) and describes earnings, which is ‘‘similar to net income in present practice,’’ as ‘‘a measure
of performance for a period’’ (FASB 1984). It implies the existence of other comprehensive income (OCI) by saying that
earnings and comprehensive income ‘‘are not the same because certain classes of gains and losses are included in

The authors appreciate the helpful comments from Yukio Ono, Atsushi Kogasaka, Tomokazu Sekiguchi, and other participants at the Accounting
Standards Advisory Forum (ASAF) meetings.
The views expressed in this paper are those of the authors and do not represent positions of the Accounting Standards Board of Japan (ASBJ).
Editor’s note: Accepted by Lynn L. Rees.
Submitted: October 2015
Accepted: July 2016
Published Online: August 2016

1
In this paper, we use the terms ‘‘net income’’ and ‘‘profit or loss’’ interchangeably.
2
In this paper, we use the terms ‘‘recycling’’ and ‘‘reclassification adjustments’’ interchangeably. Section 220-10-20 of the FASB Accounting Standards
Codification defines ‘‘reclassification adjustments’’ as ‘‘adjustments made to avoid double counting in comprehensive income items that are displayed as
part of net income for a period that also has been displayed as part of other comprehensive income in that period or earlier periods.’’
511
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comprehensive income but are excluded from earnings’’ (FASB 1984). However, it does not discuss whether, and if so, when,
OCI items should be recycled.
The current Conceptual Framework of the International Accounting Standards Board (IASB) neither defines net income
nor comprehensive income. Nor does it discuss whether, and if so, when, OCI items should be recycled. The IASB is currently
revising its Conceptual Framework and has tentatively concluded that ‘‘it is not feasible or appropriate to attempt to define, or
precisely describe, in the Conceptual Framework when an item of income or expense should be included in the statement of
profit or loss or OCI’’ (IASB 2015).
The Accounting Standards Advisory Forum (ASAF), which functions as the external advisory group for the IASB’s
Conceptual Framework project, has been discussing the issue of reporting financial performance and its implications for
measurement. Consistent with what the Accounting Standards Board of Japan (ASBJ) proposed at the ASAF meeting, we
propose in this paper the definitions of net income and comprehensive income and an approach to measurement based on
these proposed definitions. We also compare our proposals with the suggestions made by others participating in the ASAF
meetings.

NET INCOME AND COMPREHENSIVE INCOME

Proposed Definitions
Consistent with what the ASBJ proposed at the December 2013 ASAF meeting (Nishikawa 2013), we propose defining net
income and comprehensive income as two separate elements of financial statements in the following manner:
Net income is the change in net assets during a period except those changes resulting from transactions with owners in
their capacity as owners, whereby the recognized assets and liabilities comprising the net assets are measured using
measurement bases that are relevant from the perspective of reporting an entity’s financial performance.
Comprehensive income is the change in net assets during a period except those changes resulting from transactions
with owners in their capacity as owners, whereby the recognized assets and liabilities comprising the net assets
are measured using measurement bases that are relevant from the perspective of reporting an entity’s financial
position.
Under these definitions, OCI would be the linkage factor that reconciles the two elements of financial statements. A
reconciliation would be required when the measurements that are relevant from the perspective of reporting an entity’s financial
position differ from the measurements that are relevant from the perspective of reporting an entity’s financial performance.

Implications of the Proposed Definitions

Two Separate Elements
Net income and comprehensive income would be defined as two separate elements of financial statements and OCI would
be used to reconcile these two separate elements. Although it is possible (and perhaps useful) to present these two elements and
the reconciliation between the two elements in a single statement, we do not support the view that net income is a mere subset
of comprehensive income.

All-Inclusiveness
Because, based on our proposal, both net income and comprehensive income are derived from the same set of recognized
assets and liabilities, the accumulated net income for the lifetime of the entity should equal the accumulated comprehensive
income for the lifetime of the entity. Furthermore, these accumulated amounts should equal the accumulated net cash inflows to
the entity (other than those resulting from transactions with owners in their capacity as owners). We refer to this relationship
with cash flows as ‘‘all-inclusiveness.’’
All-inclusiveness supports the integrity of net income through its consistency with cash flows and makes net income more
significant than a mere subset of comprehensive income. All-inclusiveness is also helpful in assessing the management’s
stewardship of the entity’s resources.

Recycling
The difference between net income and comprehensive income is essentially a timing difference. If net income and
comprehensive income are to be presented in a single statement, then there must be a procedure that reconciles the timing
difference between the two elements of financial statements (that is, an amount must be added or subtracted in a certain period

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and reversed in a subsequent period [or periods]). The procedure of recycling3 reconciles this timing difference for a certain
OCI item, but for completeness, all OCI items must be recycled.

PROPOSED APPROACH TO MEASUREMENT

Focus on Financial Performance

Based on our proposed definitions of net income and comprehensive income, a measurement basis for a certain item would
be selected from the perspective of reporting an entity’s financial position and a measurement basis for the same item would be
selected from the perspective of reporting an entity’s financial performance. In most cases, the measurement bases selected for
the two perspectives would be the same.
We propose that the measurement basis for an item should first be selected from the perspective of reporting an entity’s
financial performance. Then, if it is determined that using a different measurement basis would provide information that is
more relevant from the perspective of reporting an entity’s financial position, then such measurement basis should be selected.
We propose this approach because information about the financial performance of an entity more directly achieves the
objective of general purpose financial reporting, which is described by the FASB and the IASB as to help ‘‘existing and
potential investors, lenders and other creditors’’ assess the ‘‘amount, timing, and uncertainty of (the prospects) for future net
cash inflows to the entity’’ (FASB 2010; IASB 2010).
We think that different measurement bases should be selected and OCI should be used as the linkage factor when doing so
results in providing relevant information. We do not think OCI should be eliminated per se, yet we also think that the
measurement bases selected from the two perspectives would be the same in most cases and, accordingly, the types of OCI
items would be kept to a reasonable number.

What Should Net Income Represent?

When selecting the measurement bases from the perspective of reporting an entity’s financial performance, it is important
to consider what net income should represent. We propose that net income represent the irreversible outcomes of an entity’s
business activities. The outcomes of an entity’s business activities become irreversible when the uncertainty regarding the
outcomes of an entity’s business activities is reduced to the point where the outcomes are irreversible or deemed irreversible.
The irreversible outcome does not necessarily need to result in conversion to cash and, accordingly, our proposal does not
suggest cash-based accounting. What is viewed to be the outcome of the business activity would depend on the initial
expectation of the entity when it enters into that business activity.
A typical example would be the recognition of revenue from the sale of inventory. An entity holds inventory with the
expectation that inventory will be sold at a price higher than its cost, but there is uncertainty regarding the price at which the
inventory can actually be sold. When the entity enters into a contract with the customer to sell the inventory at a specified price
and delivers that inventory to the customer, the uncertainty is reduced to the point where the outcome is irreversible and thus
revenue would be recognized.
The outcome of an entity’s business activities also becomes irreversible when the uncertainty has reduced to the point
where it has become certain that the initial expectation can no longer be achieved. A typical example would be the recognition
of impairment losses.

Selecting Measurement Bases for Reporting Financial Performance

When an asset (or a liability) is readily converted to cash (or settled) and the entity’s business activity does not legally,
contractually, or economically restrict the entity’s opportunity to convert the asset to cash (or settle the liability), the change in
the current value of such asset (or liability) is deemed irreversible because the entity has willingly accepted the uncertainty
regarding the fluctuations in the current value. Accordingly, the change in the current value represents the outcome of this
business activity and thus should be recognized in net income when that change occurs. It follows that such asset (or liability)
should be measured at its current value from the perspective of reporting an entity’s financial performance. For example, the
change in the current value of equity instruments held for trading would be recognized in net income when that change occurs,
even when the entity has not sold those equity instruments.
In most other cases, however, the change in the current value of the asset (or liability) is reversible or deemed reversible
because the uncertainty regarding the outcome of the entity’s business activity has not been sufficiently reduced. It follows that

3
We note that the term ‘‘recycling,’’ which implies that something is used again and suggests double counting, is misleading, because there is nothing
double counted in net income.

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such asset (or liability) should be measured at its historical cost from the perspective of reporting an entity’s financial
performance. If it is determined that a measurement basis other than historical cost should be used from the perspective of
reporting an entity’s financial position, then OCI should be used as the linkage factor and the OCI item should subsequently be
recycled.
For example, if an entity is legally, contractually, or economically restricted to sell the equity instruments it holds, then
those equity instruments would be measured at historical cost from the perspective of reporting the entity’s financial
performance. Nevertheless, if those equity instruments are measured at current value from the perspective of reporting the
entity’s financial position, then the change in the current value of those equity instruments would be included in comprehensive
income. The difference between net income and comprehensive income would be reconciled as OCI.

Why Historical Cost Is Relevant

Some may question why we propose historical cost as the measurement basis when the outcomes are yet to be irreversible
or deemed irreversible from the perspective of reporting an entity’s financial performance. We think historical cost is the most
appropriate measurement basis in this case because the changes in the value of the assets and liabilities from using other
measurement bases are not robust enough to be relevant, that is, to have confirmatory value or predictive value (or both).4 In
other words, using other measurement bases and recognizing changes in the value of the assets and liabilities in net income
would create unnecessary ‘‘noise’’ if such changes may eventually reverse.
The Conceptual Framework states that the objective of financial reporting is to help users ‘‘assess the prospects for future
net cash inflows to an entity’’ (FASB 2010; IASB 2010), and in this context, some may argue that historical cost has no
relevance. As discussed in the previous paragraph, however, we think historical cost measurements provide useful information
in the context of providing predictive value, confirmatory value, or both and thus provide relevant information.

IMPLICATIONS FOR STANDARD-SETTING

Our proposed approach acknowledges that the objective of reporting the financial performance of an entity and the
objective of reporting the financial position of an entity may be different and that different measurement bases may be selected
for the same item. We think this allows accounting standard-setters more flexibility in selecting the most relevant measurement
bases from each perspective.
Furthermore, our proposed approach has the advantage that net income is defined directly (that is, not as a residual). The
all-inclusiveness of net income supports its integrity and makes net income more significant than a mere subset of
comprehensive income. We note that this is consistent with how many market participants currently view net income.
Another advantage of our proposed approach is that it clarifies how to use OCI and justifies the need for recycling. OCI is
used to reconcile the two separate elements of financial statements, namely net income and comprehensive income. Because the
difference between net income and comprehensive is a timing difference, an amount must be added or subtracted in a certain
period and reversed in a subsequent period (or periods). By describing OCI and recycling in this manner, standard-setters no
longer need to make ad hoc determinations as to whether a certain OCI item should be recycled in a subsequent period (or
periods).
Our approach suggests that OCI is necessary and thus should not be eliminated. This is because OCI is the linkage factor
that reconciles net income and comprehensive income. If OCI was eliminated and only comprehensive income was to be
presented in the financial statements, then we do not think those financial statements would appropriately report the financial
performance of the entity. While we agree that OCI has some information value in its own right, the primary objective of
present OCI is to reconcile net income and comprehensive income.

COMPARISON WITH SUGGESTIONS MADE BY OTHERS

Linsmeier (2016)
Focus on Financial Performance and Recycling
We agree with Linsmeier (2016) that the selection of measurement bases should focus on the implications for the income
statement. However, Linsmeier (2016) further suggests that the measurement basis selected from the perspective of reporting
an entity’s financial performance and that selected from the perspective of reporting an entity’s financial position would not

4
The Conceptual Framework states that ‘‘relevant information is capable of making a difference in the decisions made by users’’ and that ‘‘financial
information is capable of making a difference in decisions if it has predictive value, confirmatory value, or both’’ (FASB 2010; IASB 2010).

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differ and thus recycling would not be needed. We are not convinced of this argument because it is likely that the objective of
reporting an entity’s financial performance is different from the objective of reporting an entity’s financial position and because
users have told us that there is a need for having different measurement bases for certain items. If different measurement bases
are used for the same item, then OCI should be used as the linkage factor and the OCI item should subsequently be recycled.

Operating Income
Linsmeier (2016) emphasizes the usefulness of operating income and suggests presenting a ‘‘Statement of Operating
Income.’’ While we do not disagree with the usefulness of operating income, we note that operating income does not have the
characteristic of all-inclusiveness and, therefore, it is useful only to the extent that it is a subset of net income. Furthermore, we
think operating income should be viewed as a subset of net income, rather than comprehensive income, because it relates to the
financial performance of an entity.

Selection of Measurement Bases

We agree with Linsmeier (2016) that the ‘‘relevance of fair value information depends on the nature of the asset or liability
and how it is being used or able to be used or transferred within the business.’’ Linsmeier (2016) suggests that whether fair
value information is relevant ‘‘primarily depends on whether there are constraints limiting management’s ability to sell an asset
or transfer a liability before maturity or the end of its useful life.’’ Our proposal related to the selection of measurement bases is
largely consistent with Linsmeier’s (2016) proposal.
However, Linsmeier (2016) applies the above concepts and concludes that reporting unrealized gains and losses on
property, plant, and equipment (PP&E) and financial liabilities are less likely to provide relevant information but reporting
unrealized gains and losses on financial assets and investment properties are more likely to provide relevant information. We do
not think it is appropriate to select the measurement bases of an asset or a liability based on its form. For example, we think
certain financial assets (such as loans) should be measured at historical cost if they cannot be readily converted to cash or if the
entity’s business activity legally, contractually, or economically restricts the entity from converting them to cash.

Marshall and Lennard (2016)

Selection of Measurement Bases
Marshall and Lennard (2016) suggest classifying businesses into ‘‘value added’’ businesses and ‘‘price change’’ businesses,
and to use cost for the measurement of the assets and liabilities of value-added businesses and current market prices for the
measurement of the assets and liabilities of price-change businesses. Our proposal related to the selection of measurement bases
is largely consistent with Marshall and Lennard’s (2016) proposal.
However, Marshall and Lennard (2016) do not entirely agree with the rationale for using historical cost and suggest that
current cost may be appropriate in certain cases. As Marshall and Lennard (2016) point out, the performance of a value-added
business should be assessed by comparing the ‘‘revenues (generally represented by cash or receivables) and the costs of inputs
consumed in providing the related products.’’ We think the costs on inputs consumed should be measured based on the
historical costs and not the current costs.

Net Income and Recycling

Marshall and Lennard (2016) note that, ‘‘if the purpose of the statement of profit or loss is to report income and expense for
the period it cannot also serve the purpose of ensuring that the cumulative reported amount of income and expenses is correct’’
and that ‘‘recycling should be used only where it enhances the relevance of profit or loss, because it represents an event of a
period, or completes the depiction of an event that is recognized in the period.’’
We think net income should not be a mere subset of comprehensive income but a separate element of financial statements
that have the characteristic of all-inclusiveness. We think it is important that the integrity of net income is supported by its
relationship with cash flows and, in order to maintain this relationship, all OCI items must be recycled. If certain OCI items are
not recycled, then net income would be incomplete and would not provide a faithful representation of the financial performance
of the entity. We also think all-inclusiveness is helpful in assessing the management’s stewardship of the entity’s resources.

CONCLUDING REMARKS
‘‘Users from all sectors incorporate profit or loss in their analyses, either as a starting point for further analysis or as the
main indicator of an entity’s performance’’ (FASB 2008; IASB 2008). We think there is a good reason that net income is deeply
ingrained in the economy, and we think standard-setters should continue to strive to define net income directly.

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Although we noted some differences in views among accounting standard-setters in the later part of this paper, we share
views in many respects and, accordingly, we do not think it is impossible to develop a definition of net income. We hope this
paper contributes to the global discussion on this issue.

REFERENCES
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Financial Accounting Standards Board (FASB). 2008. Preliminary Views on Financial Statement Presentation. Discussion Paper.
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Financial Accounting Standards Board (FASB). 2010. Conceptual Framework for Financial Reporting—Chapter 1, The Objective of
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(4).
Nishikawa, I. 2013. Profit or Loss/OCI and Measurement. Agenda Paper 3 for the Accounting Standards Advisory Forum Meeting,
December 5–6, London, U.K. Available at: http://www.ifrs.org/Meetings/MeetingDocs/ASAF/2013/December/
AP3%20Profit%20and%20Loss,%20Measurement%20and%20OCI.pdf

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