Accumulated other comprehensive income (OCI) is a sea into which various unrecognized gains and losses are poured. In the United States, largely consists of currency adjustments, unrealized gains and losses on available for sale securities, gains and losses on derivatives held as cash flow hedges, actuarial gains and losses on defined benefit plans recognized, and changes in the revaluation surplus. For example, in its 2023 10-K filing, HF Sinclair Corp. reported an accumulated other comprehensive loss of $11.78 million, whose breakdown is given on page 122:
IFRS also recognised an accumulated OCI account within shareholder’s equity, although each reserve is reported separately.
It is obvious that the nature of the items within the accumulated OCI are both volatile and not immediately available for deployment by management. Therefore, accumulated OCI is removed from my calculation of invested capital.
A note must be made of the impact of the Financial Accounting Standard Board’s (FASB) Accounting Standards Update (ASU) 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,”which was voted in in 2016 and came into effect in 2018. Warren Buffett excoriated the update in his 2017 letter to Berkshire Hathaway’s shareholders, saying,
Berkshire’s gain in net worth during 2017 was $65.3 billion, which increased the per-share book value of both our Class A and Class B stock by 23%. Over the last 53 years (that is, since present management took over), per- share book value has grown from $19 to $211,750, a rate of 19.1% compounded annually.*
The format of that opening paragraph has been standard for 30 years. But 2017 was far from standard: A large portion of our gain did not come from anything we accomplished at Berkshire.
The $65 billion gain is nonetheless real – rest assured of that. But only $36 billion came from Berkshire’s operations. The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code. (Details of Berkshire’s tax-related gain appear on page K-32 and pages K-89 – K-90.)
After stating those fiscal facts, I would prefer to turn immediately to discussing Berkshire’s operations. But, in still another interruption, I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire’s net income figures and very often mislead commentators and investors.The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period. Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire’s “bottom-line” will be useless.
“Chairman’s Letter”, Warren Buffett
Before the update, firms could class equity securities as either trading securities, available-for-sale securities, or cost-method securities. Changes in the fair value of trading securities were recognised through net income, while those of available-for-sale-securities were recognised in OCI, with dividends recognised through net income. Cost-method securities, which had no easily determinable fair value, were reported at cost minus impairment, with dividends and impairment losses recognised in net income. Under the update, equity securities are now all be measured at fair value through earnings and classed as equity investments, or as equity investments accounted for using the equity method. Where equity investments are not part of a firm’s consolidated financials or accounted for under the equity method, firms will have to either recognise changes in fair value through net income, or at cost, minus impairment, and plus or minus subsequent adjustments for observable price changes, with changes in the basis of these investments ported in the firm’s current earnings. The import of this is to treat equity securities as if they were all trading securities under the ancien régime, except for those without readily determinable fair values, which are accounted for under the modified cost method. The fair values are, nevertheless, adjusted to reflect observable price changes in similar equity investments.
Non-financial companies disclose unrealised gains and losses from equity investments under “Other income (expense) on the income statement, while financial companies disclose them in the notes to the financial statements. “Other income (expense) does not form part of my calculation of NOPAT, so, for post-2018 results, there is no impact on my treatment of the income statement. Because financial companies disclose unrealised gains and losses in more idiosyncratic ways, changes have to be made by first going through the notes and finding them.
Because unrealised gains and losses are now recognised through net income, accumulated OCI is artificially decreased, affecting my calculation of invested capital. Under the old rules, the fair value was reported on the balance sheet and the cost basis, the capital deployed to make the investments, was disclosed in the notes, along with the fair value and net unrealised gains and losses of their equity investments. To reflect the cost of the equity investments, one merely had to deduct the accumulated OCI from fixed assets. With ASU 2016-01, unrealised gains and losses are no longer in accumulated OCI. Where firms disclose the cost basis, fair value and net unrealised gains and losses of their equity investments, I can recalculate accumulated OCI under the old rules, adding back the cumulative net unrealised gains and losses to accumulated OCI, net of taxes and minority interests, which allows for more consistency in treatment of both accumulated OCI and fixed assets. However, this is not always the case. Without quarterly reporting of these components, I have to add the incremental unrealised gains and losses through the reporting periods, net of estimated taxes, minority interests and gains on sale of equity securities, to the prior net unrealised gains and losses figure, to try and ape how accumulated OCI was formed under the old rules.