Keywords

forecast error and dispersion, investor information processing, experimental and archival evidence, financial statement presentation

Abstract

We characterize the operating-activities section of the indirect-approach statement of cash flows as backwards because it presents reconciling adjustments in a way that is opposite from the intuitively appealing, future-oriented, Conceptual Framework definitions of assets, liabilities and the accruals process. We propose that the reversed-accruals orientation required in the currently mandated indirect-approach statement of cash flows is unnecessarily complex, causing increased cash-flow forecast error and dispersion. We also predict that the mixed pattern (i.e., +/–, –/+) of operating cash flows and operating accruals reported by most companies also impedes investors’ ability to learn the time-series properties of cash flows and accruals. We conduct a carefully controlled experiment and find that (1) cash-flow forecasts have lower forecast error and dispersion when the indirect-approach statement of cash flows starts with operating cash flows and adds changes in accruals to arrive at net income and (2) cash-flow forecasts have lower forecast error and dispersion when the cash flows and accruals are of the same sign (i.e., +/+,–/–) with the sign-based difference attenuated in the forward-oriented statement of cash flows. We also conduct a quasi-experiment to test our mixed-sign versus same-sign hypotheses using an archival sample of publicly available Value Line cash-flow forecasts. We find that Value Line analysts’ cash-flow forecasts exhibit the same pattern of forecast error as documented in our experiment.

Original Publication Citation

Hodder, L., P. E. Hopkins, and D. A. Wood. 2008. The effects of financial statement and informational complexity on cash flow forecasts. The Accounting Review, 83 (4): 915-956. DOI: 10.2308/accr.2008.83.4.915.

Document Type

Peer-Reviewed Article

Publication Date

2006

Publisher

The Accounting Review

Language

English

College

Marriott School of Business

Department

Accountancy

University Standing at Time of Publication

Full Professor

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