Wednesday, March 13, 2013

Comprehensive Income

With the change of the accounting rules to IFRS from Canadian GAAP, one of the financial ratios suggested to be used was a ROE based on comprehensive income.

As I understand the accounting change, most of the financial ratios under IFRS present a significantly higher volatility than those computed under pre-changeover Canadian GAAP. Although the effects of IFRS on means and medians of ratios related to the financial condition of companies are not statistically significant, maximum values of several ratios are higher and the minimum values are lower under IFRS.

There is a significant difference in the distribution of values around medians for such ratios as current and quick ratios, debt, alternative-debt and equity ratios, interest coverage, fixed-charge and cash-flow coverage, return on assets (ROA), comprehensive-ROA and price-earnings related ratios. Results of regression analysis confirm the increased volatility of IFRS leverage and profitability ratios.

In general, IFRS does not materially change the cash flow statement when compared to pre-changeover Canadian GAAP.

From a paper I read it was suggested the use of two ratios when analyzing comprehensive income. They were the comprehensive-ROA (return on assets) and the comprehensive-ROE (return on equity). These are an adaptation of the regular ROA/ROE but with the comprehensive income as the numerator.

The paper I read was called The Effects of IFRS on Financial Ratios: Early Evidence in Canada by Michel Blanchette, Francois-Eric Racicot and Jean-Yves Girard. This paper can be found at here. This paper suggests that if there are differences between the ROE on Net Income and Comprehensive Income, it should be investigated. This can be done easily by looking at the financial statements and the calculation of the comprehensive income. This calculation starts with Net Income. See the statement called "Consolidated Statements of Comprehensive Income".

I had read somewhere that if there was a significant difference between the ROE on net income and comprehensive income this would call into question the quality of the net income. It is basically a warning. I cannot find where I read this, but there is a good article on comprehensive income at Credit Institute of Canada.

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