Thursday, September 06, 2007

Other Comprehensive Income

Everybody knows the Accounting Equation: Assets = Liabilities + Equity.

Now the Equity portion of the equation is what the owners puts in into the business when they start a business. It also includes the money that comes into the company by issuing common stock. So if you and I were to buy shares into the company, we would also become the owners. With this overwhelming feeling also comes risk involved. The risk of losing all the money that you and I have put into our business. If our business were to fail it would take with it all our capital. So it becomes imperative to know what are the avenues where the equity increases or decreases. There are 4 such methods in which it could be affected.

Unrealized Gain/Loss on AFS Securities
AFS is available for sale securities. These are stocks of other companies that you have bought and can be readily sold in the market, but you decide not to sell them for the entire accounting period. The accounting period may be a full year, or a quarter or whatever. For example you have 100 shares of company A, valued at Rs. 100 each. So at the start of the year the value of the securities is Rs. 10,000. Although you have not done any work, yet by merely holding the securities the value of those would have increased or decreased. That essentially increases or decreases the owners' equity.

Translation Error
Suppose you were to buy 100 bottles of Château Cheval Blanc red at the start of the year for a total of 100,000 francs at the start of the year. And suppose at the end of the year it still costs the same in francs. But you would have paid in rupees or whatever currency is local to you. Now if the currency conversion rate of rupee vs. the franc at the start of the year were to be 1 franc = Rs. 35 and at the end of the year it were to change to 1 franc = Rs. 30, the change in the value of your asset would be Rs. 5,00,000. Again no transactions but you are affected by the currency rate fluctuations.

Minimum Pension Liability
Every month your company collects a percentage of your salary as your contribution towards EPF (Employees' Pension Fund) and contributes an equal amount on its own. It then invests that amount in hopes of being able to give you some interest on that money at some later date. Now depending upon its investment, there would be a deficit or gain in the amount in the fund and the promised amount it has to give out as pension to its employees. This needs to be reported in the company's balance sheet against owners' equity.

Cash Flow Hedges
Assume the case of a manufacturing company. It runs on raw materials to produce finished goods. In most cases the production planning supervisor would know the amount of raw materials the company would need, say, 6 months down the lane. Some of the materials are to be imported and paid in dollars. The company expects that the rupee-dollar exchange rate to change drastically in that time. So the company makes a deal with someone else, that for a fixed amount of rupees that person would give the company a fixed amount of dollars with which the company can pay for the raw materials. If the reporting were to happen between now and then, and supposing the exchange rate has changed, the change is to be reflected in the accounting books. Note, that the transaction has not happened as yet. But the company has committed the money at some level to the apparent profit/loss needs to be reported. In fact this is one of the ways in which TCS recently managed to give better results than expected.


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