The Relevance of a Segment Cash Flow Statement in Lending Decisions: An Empirical Study

The purpose of this study is to examine the relevance of a segment cash flow statement in the lending decisions of commercial bank loan officers. 117 loan officers made short term, intermediate term, and long term lending decisions using case materials prepared for a company that operates in two industries—soft drinks and farm machinery/equipment. Results indicate that segment cash flow statements are relevant in lending decisions under certain circumstances. When given the ‘good news’ that a stable industry was the cash source, loan officers in the soft drinks group granted more long term loans than those in the control group. When given the ‘bad news’ that a troubled industry was the cash source, loan officers in the farm group made smaller short term loans than those in the control group.     

A Neural Network Approach for Analyzing Small Business Lending Decisions

In this paper, we apply the neural network method to small business lending decisions. We use the neural network to classify the loan applications into the groups of acceptance or rejection, and compare the model results with the actual decisions made by loan officers. Data were collected from a leading bank in Central New York. The sample contains important financial statement and business information of borrowers and the loan officers' decisions. We conduct the network training on the data sample and find that the neural network has a stronger discriminating power for classifying the acceptance and rejection groups than traditional parametric and nonparametric classifiers. The results show that the neural network model has a high predictive ability. Our findings suggest that neural networks can be a very useful tool for enhancing small-business lending decisions and reducing loan processing time and costs.     

Revenue Recognition in the Construction Industry: An Experimental Study

There have been suggestions that loan officers do not consider there is a problem in the availability of alternative revenue recognition methods, provided that sufficient disclosure of recognition procedures is made to enable adjustment of financial statements. On the other hand, the accounting literature on'functional fixity' suggests such adjustments are not made. The functional fixity literature has relied exclusively on testing for an accounting method effect on user predictions and decisions. As a result, the evidence can be interpreted as users being fixated on earnings and ignoring information about accounting methods or alternatively they may have given attention to that information and attempted a transformation although the extent of the adjustment was'inadequate'. This paper suggests that the previous evidence on functional fixity is inconclusive about lenders' suggestions that they adjust financial statements and that different actions may be required by lending institutions depending on which interpretation of the functional fixity literature is made. This study uses the joint methodologies of analysis of variance and protocol analysis to focus on both whether adjustments are made as well as whether alternative methods of recognizing profit from longterm contracts affect the judgements of experienced lenders. The results show that the majority of subjects did not attempt to adjust for alternative methods of recognizing revenues.     

The Predictive Ability of Direct Method Cash Flow Information

This research examines the predictive ability of direct method cash flow information for firms that use the direct method in their cash flow statements. We use cross sectional and pooled time series regressions to predict operating cash flow data and assess relative predictive ability. Principal findings are: (1) past period direct method cash flow data predict future operating cash flow better than indirect method cash flow data; (2) past period direct method gross operating cash flows predict future net operating cash flow better than past period net operating cash flow; (3) measurement error exists in estimates of direct method operating cash flows from other financial statement data; (4) past operating cash flows predict future operating cash flows better than earnings and accruals.     

'Shopping Around' for Accounting Practices: The Financial Statement Presentation of French Groups

This article illustrates the progressive move away from traditional accounting practices through a study of the presentation of financial statements. Based on a sample of one hundred large French industrial and commercial groups over a ten-year period, and applying a logistic regression method, our survey confirms a trend among French companies, which are increasingly turning their backs on traditional national practices as regards the balance sheet format, the income statement format, the voluntary disclosure of a statement of changes in shareholders' equity and the cash flow statement format. This move towards 'alternative' practices is made possible by the flexibility of French regulation, and can probably be explained by the desire of French firms to attract more investment on international capital markets. However, this trend shows no signs of a clear orientation towards any particular accounting model (IAS, U.S. or U.K.). The behaviour of the French firms observed in our study can be considered as a kind of 'shopping around' for accounting practices.     

Did Australian Firms Choose to Switch to Reporting Operating Cash Flows Using the Indirect Method?

In 2007 Australian accounting standards were amended to allow a choice of presenting operating cash flows using either the direct or indirect method. This study investigates the number of ASX‐listed entities that switched to the indirect format. Our results indicate that between 2007 and 2009 nine companies changed their reporting format. The firms adopting the indirect method have similar leverage, liquidity and performance to industry and size‐matched controls. Given that previous research indicates that the direct method provides superior information for predicting cash flows and performance, our results will be welcomed by financial statement users and the Australian Accounting Standards Board.     

Making up users

Within recent years, financial statement users have been accorded great significance by accounting standard-setters. In the United States, the conceptual framework maintains that a primary purpose of financial statements is to provide information useful to investors and creditors in making their economic decisions. Contemporary accounting textbooks unproblematically posit this purpose for accounting. Yet, this emphasis is quite recent and occurred despite limited knowledge about the information needs and decision processes of actual users of financial statements. This paper unpacks the taken-for-grantedness of the primacy of financial statement users in standard-setting and considers their use as a category to justify and denigrate particular accounting disclosures and practices. It traces how particular ideas about financial statement users and their connection to accounting standard setting have been constructed in various documents and reports including the conceptual framework and accounting standards.     

The Free Cash Flow Anomaly Revisited: Finnish Evidence

Abstract:  This paper examines the performance of an investment strategy based on free cash flows using financial statement data of Finnish companies during the period 1992-2002. The analysis in this paper is motivated by the so-called free cash flow anomaly previously documented e.g. in Hackel, Livnat and Rai (2000) . Using annual financial statement information, we identify large-capitalization companies with positive free cash flows, low free cash flow multiples, and low financial leverage. Since a portfolio of these companies is found to consistently outperform the market index, our results suggest that the free cash flow anomaly also exists in the Finnish stock market.     

An Evaluation of the Decision Usefulness of Cash Flow Statements by Australian Reporting Entities

In June 1991, the Australian Accounting Standards Board issued AASB 1026, Statement of Cash Flows. Since replacing the funds flow statement, the new accounting standard has become a compulsory part of Australian corporate financial reporting. In contrast to cash flow developments in the US and UK. the emergence of AASB 1026 has been preceded by almost no significant research attention by Australian academics. This study surveyed the attitudes to cash flow statements of 210 public companies listed on the Australian stock exchange. Findings revealed that there was particularly strong support for the essential provisions of AASB 1026 and the underlying principles of cash flow reporting. The results indicated that the cash flow statement is important for a wide variety of internal and external decision contexts, and appealed to a wide range of users. Furthermore, compared with previous research (e.g. McEnroe, 1989), the present survey demonstrated that operating profit was not considered by a large number of Australian companies to be a superior measure of business performance to operating cash flow.     

Accounting aggregation: User preferences and decision making

This experiment tests the effects of alternative aggregations of accounting data in a simulated portfolio task. Certain entropy-based aggregation criteria were used to prepare differentially aggregated financial statements for use in the task. Subjects made allocations of initial edowments between hypothetical firms, disclosed confidence in their allocation decisions and reported on specific characteristics of the financial statements. Differences in reported usefulness of statement sets furnished were found to be associated strongly with measured information content. The results also provide limited evidence that decisions and judgments of subjects were affected by the information content of the accounting aggregations provided.     

Using accounting equation analysis to teach the statement of cash flows in the first financial accounting course

Understanding the statement of cash flows requires that students have some knowledge of accrual-basis accounting. This means that coverage of the statement of cash flows is deferred until late in the introductory financial accounting course and related textbooks, a time when student motivation and retention may be waning. The timing of statement of cash flow coverage is unfortunate for two reasons. First, the statement of cash flows is an important topic that all business students need to understand. Second, most students understand cash flows at the start of their financial accounting class, so there is no reason to defer coverage of this topic.This paper describes a user-oriented, pedagogical approach to integrating the statement of cash flows throughout the first financial accounting course. The essence of this approach is the use of an expanded accounting equation with temporary cash accounts corresponding to the major categories on the statement of cash flows. Directly capturing cash flow information simplifies the preparation of the statement of cash flows.     

Perceptions and characteristics of financial statement users in developing countries: Evidence from Iran

We examine the perceptions and characteristics of users of corporate financial statements in Iran. We provide evidence based on a survey of seven different user-groups. Our results suggest that annual reports are regularly used as a basis for making investment and other economic decisions. As in many developing countries, users depend more heavily on information obtained from the published annual reports than on advice from stockbrokers and acquaintances or on tips and rumors. While respondents differed in their rating of the importance of different sections of the annual report, the overall results showed that they ranked the income statement, the auditors’ report, and the balance sheet as the three most important parts of the annual report (in that order). There is a weak level of consensus among bank loan officers, tax officers, and auditor groups about the importance of several information items. Most users believe that a delay in publishing annual reports, lack of reliability of the information, and lack of adequate disclosure are the main concerns with corporate financial reports in Iran. The evidence on Iran is relevant to other developing countries in the Middle East and beyond.     

Overseas bankers in the UK and their use of information for making lending decisions: Changes from 1985

This paper is concerned with the information used by one set of users, namely bankers, and the changes in their usage of information over time. The work replicates and revisits the work of Berry, A., Citron, D., Jarvis, R., 1985. Foreign banks operating in the UK—their information requirements, usage and suggested improvements to financial reporting, implications for the accounting profession. European Accounting Association Conference, Brussels. The population surveyed was drawn from the same source as that used for the earlier study although, as might be expected in a dynamic environment, the individual bankers making up that population were not identical. The results show that accounting information, as a whole, remains a very important source of information informing the bankers' decision-making processes but that the relative importance and usage of the components has changed. Some of these changes are positive in that they suggest that there have been improvements to the information content provided, for example in contrast to the findings of Bartlett, S.A., Chandler, R.A., 1997. The Corporate Report and the private shareholder: Lee and Tweedie twenty years on. British Accounting Review 29, 245–261, the cash flow statement is seen as more important than the profit and loss account or balance sheet. Other changes are perhaps of more concern to accounting standard setters as the results represent a decrease in the perceived importance of key components of financial statements, for example, the audit report and the statement of accounting policies. This supports the earlier findings of Bartlett and Chandler (1997) in respect of the audit report. There is also evidence to suggest that the mix and type of information these bankers are now using has changed since 1985. This may indicate a move toward a greater use of a going concern approach to lending decisions.     

Articulation in cash flow statements: a resource for financial accounting courses

Recent accounting research (Bahnson, P., Miller, P., & Budge, B. (1996). Nonarticulation in cash flow statements and implications for education, research and practice. Accounting Horizons, 10, 1–15 has shown that firms implementing the indirect method for reporting cash flows under SFAS 95 rarely produce financial statements that articulate cleanly. The purposes of this paper are (1) to provide financial accounting educators with a list of companies for which articulation does exist, (2) to describe the process by which educators can update the list in the future, or modify it to suit their own preferences, and (3) to present an analysis of firms’ reporting practices on the cash flow statement, which may be of interest to more advanced students studying the complexities of the statement of cash flows. This analysis of reporting practices involves an assessment of the articulation of individual COMPUSTAT line items (e.g. inventory) and subsets of line items (e.g. inventory, receivables, deferred taxes, and depreciation) for the 1998 data year. The findings indicate that relatively few firms report consistent values for single line items and that very few firms report consistent values across subsets of line items. Although the rate of articulation decreases as firm size, and hence reporting complexity, increases, 74 large, publicly-traded firms for which clean articulation does exist were identified. This list of firms should prove useful to introductory accounting educators who use real-world examples for classroom purposes.     

Determinants and economic consequences of cash flow restatements

The FASB, PCAOB, SEC, and AICPA have all acknowledged that the accounting field needs to revisit the statement of cash flows (SCF). While the overall number of restatements has held steady over the past five years, the percentage of cash flow restatements (CFRs) has risen from 8.7% of all restatements in 2009 to 20.2% of all restatements in 2014. We examine the determinants of CFRs, investors’ differential beliefs about CFRs, and the information content of CFRs by focusing on abnormal trading volume and price reactions to CFRs. We then examine whether the guidance the SEC/AICPA published in early 2006 changed the information content of CFRs. Finally, since the proper classification within the SCF is a current regulatory issue, we examine whether classification shifting within the SCFs impacts the market. The market finds CFRs to be informative with some investor disagreement as shown by higher abnormal trading volume. We also find an incremental volume reaction to changes in operating cash flows after the SEC allowance period. While the market responds negatively to CFRs, we find that the market does not differentiate between whether classification shifting occurs or does not occur with the CFR. This study has implications for policymakers, auditors, and investors since it is one of the first to examine the capital market consequences of CFRs.     

Professional accountants and the development of a management accounting service for the small firm: barriers and possibilities

This paper reports the results of a qualitative study examining the potential for the provision of a management accounting service for smaller companies by accountants in professional practice. The study aimed to determine the management information needs of owner-managers, the type and frequency of information preferred and the capacity of professional accountants to contribute to these needs. The owner-managers of 15 smaller companies were asked to participate in semi-strucutured interviews during which their use of computers to provide management accounts, their relationship with their accountant and their financial skills were discussed. The respondents were presented with a range of management information including statutory final accounts, interim accounts, cash statements, ratios and graphical comparisons of monthly turnover figures in order to assess their financial information skills and needs. The study found that companies used computers for the preparation of management accounting information, but usually not to their full potential. The financial awareness of owner-managers varied considerably. There was a favourable response to the presentation of ratios and graphs, however, it was felt that an explanation or interpretation of financial information by their accountant would be a useful addition to improve their understanding and therefore aid their business. The study concludes that there appears to be significant potential for accountants to expand the management accounting services they provide to smaller companies, especially where information is presented as ratios or graphs and accompanied with an appropriate narrative interpretation. This would also increase the financial skills of their clients and result in an increased demand for management accounting services.     

The Value of Financial Statement Verification in Debt Financing: Evidence from Private U.S. Firms

I examine how verification of financial statements influences debt pricing. I use a large proprietary database of privately held U.S. firms, an important business sector in which the information environment is opaque and financial statement audits are not mandated. I find that audited firms have a significantly lower cost of debt and that lenders place more weight on audited financial information in setting the interest rate. Further, I provide evidence of a mechanism for this increased financial statement usefulness: accruals from audited financial statements are better predictors of future cash flows. Collectively, I provide novel evidence that audited financial statements are more informative and that this significantly influences lenders’ decisions.     

An experimental study of users’ responses to qualified audit reports in China

This paper presents the results of an experimental study on users’ responses to the qualification of audit reports in China. By employing the type of audit report (e.g., unqualified vs. qualified auditor opinion) as a manipulated variable in the experiment, we found mixed responses from the participants towards the perceived impact of a qualified audit report on users’ understanding and use of the financial statements. In general, Chinese users, credit and loan officers in particular, perceived a qualified auditor opinion as having a somewhat negative impact on the credibility of financial statements. However, no significant difference was found in users’ investment or credit decisions with respect to their exposure to the financial statements accompanied by an unqualified or a qualified auditor opinion. The study findings suggest that the U.S.-style qualified audit reports have fairly limited “information content” to users in the present Chinese auditing environment and that there is a need to further improve Chinese auditing standards and practices. In addition, the study provides some insights into recent auditing developments in China.