Direct or Indirect Cash Flow Statements?

The Australian Accounting Standards Board (AASB) and the Financial Reporting Standards Board (FRSB) have issued a joint proposal that will allow reporting entities to choose between the direct and indirect method of reporting cash flow statements. This evidence presented in this paper indicates that the direct cash flow reporting format, relative to the indirect method, leads to better prediction of future firm performance and has a stronger association with share prices. The AASB and the FRSB have to decide whether to support high quality reporting or harmonisation.     

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.     

The Impact of Mandated Cash Flow Disclosure on Bid‐Ask Spreads

Abstract:   This study provides evidence that mandatory cash flow disclosure required by Approved Australian Accounting Standard AASB 1026, Statement of Cash Flows (June 1992) was associated with a decline in bid‐ask spreads following the introduction of the regulation, even after controlling for changes in trading volume and price volatility. More pronounced decreases in bid‐ask spreads were associated with firms having lower correlations between reported CFO and estimates of CFO using balance sheet reconstructions. We conclude that mandatory cash flow disclosure reduces information asymmetry across market participants.     

Compliance Over Time by Australian Firms with IFRS Disclosure Requirements

Prior literature indicates that compliance with International Financial Reporting Standards (IFRS) is not complete in many countries. This study examines practice under the Australian version of IFRS by measuring compliance with the disclosure requirements of eight standards. The study focuses on data drawn from the consolidated financial statements of a sample of the top 200 Australian listed companies. To enable a time‐series analysis of compliance over time, this study examines three reporting years: 2006, 2010 and 2014. This research identifies material non‐compliance among Australian companies, finding that some disclosure items appear to be neglected by companies, such as some of the requirements of AASB 137 Provisions. This non‐compliance raises questions about accounting and audit quality in Australia. It may suggest poor regulatory oversight.     

The Rise and Demise of Abnormal Items

Before 2001, Australian companies reported abnormal items on the face of the income statement or by way of note. In response to perceived abuses in classifying items as abnormal, AASB 1018 was reissued in October 1999 with the reference to abnormal items removed. We analyse the implications of the changes to accounting standard requirements relating to abnormal items, and examine whether there is empirical evidence of opportunistic classification of operating profit items as abnormal. Our results suggest that some companies may have opportunistically classified large expense items as 'abnormal' to boost their reported 'normal' earnings number.     

Do principles‐based accounting standards lead to biased financial reporting? An Australian experiment

International accounting standards are deliberately designed to be principles‐based (i.e. ‘substance over form’). With Australia's recent adoption of international accounting standards, a relevant question is, do principles‐based accounting standards lead to biased financial reporting? The present paper describes a study that analysed the consolidation judgements of senior accounting officials from Australian listed companies. Participants made consolidation judgements based on AASB 1024 Consolidated Accounts. Although AASB 1024 is not identical to IAS 27 Consolidated and Separate Financial Statements, there are many similarities and both follow a principles‐based approach. In aggregate, the present study finds that principles‐based accounting standards do not necessarily lead to biased financial reporting.     

Developing Accounting Regulations that Reflect Public Viewpoints: The Australian Solution to Differential Reporting

In this paper, we analyse the factors that have shaped the approach taken by the Australian Accounting Standards Board (AASB) in addressing the issue of differential reporting in Australia. In contrast to its early adoption of International Financial Reporting Standards in 2005, the AASB has signalled an independent approach to differential reporting. Still in progress at the time of writing, we show how the AASB's approach has been shaped by feedback from key stakeholder groups, as well as by influential individuals and key events. In the face of strongly held views on both sides of the debate, the Board has moved from reliance on discursive techniques to develop and justify proposed policies to embracing to a greater extent, the use of more objective research evidence to resolve the empirical questions presented in the public debate.     

Changes in Segment Reporting in the Australian Banking Industry

This paper examines changes in segment reporting in the Australian banking industry following the introduction of the revised AASB 1005 Segment Reporting. We find that the standard has implications for the qualitative characteristics of "understandability" and "comparability". Feedback on the revised standard is timely, as both the AASB and the IASB have recently issued new segmental reporting standards that are based on US GAAP's management approach of determining operating segments.     

Segment Reporting Practices in Australia: Has IFRS 8 Made a Difference?

This study examines changes in segment reporting in Australia following the adoption of the international accounting standard, IFRS 8 Operating Segments. We analyse segment disclosures of the top 200 companies listed on the Australian Stock Exchange in their pre‐ and post‐adoption of AASB 8, the equivalent Australian standard to IFRS 8. Our findings indicate that the number of reportable segments and the extent of disclosure have increased post‐adoption of AASB 8. Contrary to expectations, however, there is very little change in the identification of reportable segments. Companies, in general, have managed to retain their segment reporting formats and disclosures from the pre‐AASB 8 period.     

GAAP,GFS and AASB 1049: perceptions of public sector stakeholders

Efforts by Australian standard‐setters to harmonise public sector financial reporting resulted in AASB 1049, which sought to bridge the divide between generally accepted accounting principles (GAAP)‐based and government finance statistics (GFS)‐based financial statements. However, whether AASB 1049 has resulted in information that is considered appropriate for the public sector has not been examined. We explore this issue by comparing the requirements of AASB 1049 with the responses from a survey of public sector stakeholders on the appropriate accounting treatment and presentation of selected financial items. The analysis suggests consensus with AASB 1049 on presentation issues but less consensus on accounting treatments.     

An Empirical Examination of Cash Flow Measures

In recent years in the United States and Canada, there has been an increasing interest in cash flow reporting and a strengthening belief that information on cash flows is valued in the marketplace. However, little research has been devoted to the issue. Regulatory bodies in the U.S. (Financial Accounting Standards Board) and Canada(Canadian Institute of Chartered Accountants) require that an enterprise should disclose separately cash flows from operating, financing and investing activities in their cash flow statements. The data in the cash flow statements are expected to help investors assess the firm's liquidity, financial flexibility and risk. On the other hand, the British Accounting Standards Committee (ASC) does not require a statement of cash flows. This study employs a cross-sectional equity valuation model to examine the association of cash flows from operating, financing and investing activities with security prices. A sample of 403 U.S. firms is used for the ten-year period of 1976–85. The results of this study indicate that there exists a strong association between the various cash flow components included in the cash flow statements and the market value of the firm.     

Value‐Added Per Share (VAPS): A Value‐Relevant Corporate Performance Metric

The authors introduce Value Added Per Share (VAPS) as a value‐relevant metric that is intended to complement earnings per share (EPS) in helping corporate managers and analysts understand and overcome the limitations of GAAP‐based reporting. VAPS discounts a firm's past and projected cash flows at its “cost of capital,” allowing companies to avoid the subjective accounting accrual process and other practices that often make EPS misleading. A company's VAPS is calculated in three main steps: (1) estimate the change in the capitalized value of after‐tax operating cash flow by taking the net change (plus or minus) of the firm's operating cash flow after taxes and dividing that number by the firm's cost of capital; (2) subtract total investment expenditures; and (3) divide by the number of shares outstanding. By capitalizing the change in after‐tax operating cash flow, one finds the net change in a firm's current operations value. By subtracting investment expenditures from that change in current operations value, the analyst gets a clearer picture of the benefit to shareholders net of the funds used to create that benefit. Consistent with basic theory, VAPS is positive when a company earns a return at least equal to its cost of capital and negative otherwise. Because of their fundamental differences, EPS and VAPS are likely to send different signals, and VAPS is expected to provide greater insight into stock price changes. The authors provide the findings of statistical tests showing the superior explanatory power of VAPS and recommend that companies publish statements of VAPS along with standard GAAP results, especially since the former can be readily calculated using the available income statement, balance sheet, and cash flow statement data.     

Disclosure of Goodwill Impairment under AASB 136 from 2005–2010

An accounting standard for goodwill, AASB 136 Impairment of Assets was implemented in Australia in 2005. However, several issues of compliance with the Standard were noted in the initial adoption periods. This study examines goodwill reporting practices in Australia over the five‐year period from 2005 to 2010. It explores the extent to which Australian listed entities complied with mandatory requirements in relation to impairment testing. Using a sample of 287 Australian listed firms, we found that compliance with the Standard's goodwill allocation requirements generally improved; however, there was still non‐compliance for all reporting periods. Also, there was a tendency for firms to define the same or smaller numbers of cash‐generating units (CGUs) than reporting segments. This suggests the existence of CGU aggregation, which may have the capacity to influence the incidence of goodwill impairment, and thereby the financial position of an entity. Coupled with non‐compliance and a lack of audit attention, compliance issues surrounding goodwill impairment testing under AASB 136 still remain of concern to regulators. The findings are useful to academics, regulators and policymakers because they signal the (lack of) compliance with AASB 136.     

Keeping it private: financial reporting by large proprietary companies in Australia

Since 2010, proprietary companies have had a choice of preparing three types of financial reports that vary in scope. We find that between 2010 and 2015, most proprietary companies in our random sample chose the lowest scope option, with very low quality financial reports. Few adopted the new option provided by AASB 1053 Application of Tiers of Australian Accounting Standards. The characteristics of the firms that adopted each type of report are consistent with the regulator's intention. Our findings should provide a better understanding of how accounting standards impact practice, and should assist regulators to reform private company financial reporting.     

Discount Rates in Disarray: Evidence on Flawed Goodwill Impairment Testing

Discount rate selection represents a centrally material factor impacting valuation models. Given the strong reliance on discounted cash flow modelling as a basis for determining an asset's recoverable amount, the judgement exercised by reporting entities regarding rate selection is of paramount importance in influencing the outcomes of the impairment testing process conducted under International Financial Reporting Standards (IFRS). The discretion surrounding rate selection could be used opportunistically to avoid or manage the timing of impairment losses to the detriment of transparency, comparability and decision usefulness. This study provides evidence consistent with the opportunism on the part of financial statement preparers, by demonstrating the existence of variances between independently generated risk‐adjusted discount rates and those disclosed as having been used by a sample of large listed Australian companies.     

The Usefulness of Direct and Indirect Cash Flow Disclosures

We investigate the ability of disclosed operating cash flow and indirect accruals components to explain annual returns for a sample of Australian firms. Consistent with claims made by accounting standard setters, we find evidence of significant explanatory power for disclosed operating cash flow components beyond aggregate operating cash flows when they also have significant incremental predictive power for future (one year ahead) operating cash flows. Accrual components also have incremental explanatory power for returns. In addition, we find evidence of significant explanatory power for operating cash flow components beyond estimates of the components (based on other financial statement disclosures) for firms with large differences between disclosed and estimated components.     

Prediction of Operating Cash Flows: Further Evidence from Australia

This paper examines empirically the relative abilities of current operating cash flows (hereafter OCF) and earnings in predicting future operating cash flows in Australia. It extends prior Australian research on cash flow prediction ( Percy and Stokes 1992 ; Clinch, Sidhu and Sing 2002 ; Farshadfar, Ng and Brimble 2009 ) by examining future cash flow predictions for one‐, two‐ and three‐year‐ahead forecast horizons; incorporating additional contextual variables likely to affect the predictive association between current cash flows or earnings and future cash flows; and comparing cross‐sectional versus time series‐based prediction models to ascertain the relative superiority of one approach over the other. Regression results reveal that the cash flow‐based models are more accurate in predicting future operating cash flows than earnings‐based models. This result, however, is moderated by firm‐specific contextual factors like firm size, negative versus positive cash flow pattern, cash flow variability and firm operating cycle. Finally, a comparison between cross‐sectional and time series approaches reveals that the cross‐sectional model outperforms the time series model for both the operating cash flows and earnings models in most of the forecast years.     

Effects of financial constraints on corporate policies in Australia

We jointly study the impact of financial constraints on Australian companies’ investment decisions and demand for liquidity. By examining a large sample of Australian firms over the period 1990–2003, we find that financial constraints not only reduce the sensitivity of investment to the availability of internal funds, but also increase the responsiveness of cash holdings to internally generated cash flows. Further analysis shows that the impact of financial constraints varies across different cash flow states; that is, financial constraints have a small effect on corporate investment and cash policies when cash flows are positive. In contrast, the severity of constraints is high in negative cash flow years in which the cost disadvantage of external finance coincides with deteriorating operating performance.     

A cash flow approach to the statement of changes in financial position

Increased emphasis on managing and reporting the cash flows of companies has been articulated by academics, professional organizations, and business managers. However, traditional accounting textbooks and course syllabi have been slow to relinquish a working capital focus for the statement of changes in financial position (SCFP). This article presents a cash flow approach to the SCFP that is ideal for classroom instructional purposes because it is intuitively appealing, managerially oriented, and reflective of a growing number of companies' public disclosures.