OCI

Managing earnings volatility: Non-GAAP versus OCI

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The remeasurement of financial assets and liabilities to current value can be a source of significant earnings volatility. Many companies mitigate this by presenting an adjusted (non-GAAP) performance metric or by reporting some gains and losses in other comprehensive income (OCI).

The insurance sector, and the recently introduced IFRS 17, provides a good example of the communication challenge arising from volatile markets. IFRS reporters are split, largely along geographical lines, between applying the OCI option in IFRS 17 and a non-GAAP approach. Both approaches present challenges for investors.

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IFRS 17 insurance: Economic versus accounting volatility

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Economic and accounting volatility for insurance companies arises from changes to estimates of fulfilment cash flows and from changes to financial markets that impact asset values and the discount rate used to measure insurance liabilities.

We explain the different sources of economic volatility for insurance companies, how these are reflected in financial statements, and why accounting volatility may not always equal economic volatility. Some economic volatility is deferred and smoothed in financial statements, and some accounting volatility may not actually be economic gains and losses at all.

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Residual income valuation: OCI and clean surplus accounting

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Considering the market’s focus on earnings, other comprehensive income (OCI) can be easily overlooked by investors. We think OCI is always important in equity analysis, but if you use a residual income approach to valuation the requirement for a ‘clean surplus’ in your model makes it vital to consider gains and losses reported outside profit and loss.

We explain clean surplus accounting and why residual income valuations only work if your forecast financial statements meet the clean surplus condition. One aspect of financial reporting where this may be particularly important is expected currency translation differences.

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