Earnings Reported under IFRS Improve the Prediction of Future Cash Flows? Evidence from European Banks

Abstract

This paper examines the relative costs and benefits of International Financial Reporting Standards (IFRS) adoption in the European Union by testing the ability of earnings computed under IFRS to predict future cash flows. The study considers the contribution of net income, comprehensive income and other comprehensive income to the usefulness of earnings to predict cash flows, and it compares IFRS with domestic Generally Accepted Accounting Principles (GAAP). Evidence from a sample of Continental European banks shows that IFRS improve the ability of net income to predict future cash flows. Comprehensive income, too, provides relevant information to predict future cash flows, although with a measurement error which is higher than that in net income for greater lags of time. In our interpretation, these findings are consistent with unrealised gains and losses recognised in other comprehensive income being more transitory and volatile in nature. Overall, our results are relevant to academics and standard setters debating the merits of IFRS adoption and to those who use financial statements and adopt reported earnings to form expectations about future cash flows.

Does Comprehensive Income Predict Future Cashflow Better Than Net Income?

“…Based on the statement of an IAI (2017) and the findings of Kim and Kross (2005), Atwood et al (2011), as well as Palea and Scagnelli (2016) Chambers et al (2007) prove empirically that other comprehensive income information has value relevance to estimating stock prices. Palea and Scagnelli (2016) found empirical evidence that comprehensive profits, as well as comprehensive profits, were broken down into net income and other comprehensive income had relationships with future cash flows. Additionally, Palea and Scagnelli (2016) found empirical evidence that comprehensive earnings have better capabilities than net profit in predicting future cash flows.…”

“…Palea and Scagnelli (2016) found empirical evidence that comprehensive profits, as well as comprehensive profits, were broken down into net income and other comprehensive income had relationships with future cash flows. Additionally, Palea and Scagnelli (2016) found empirical evidence that comprehensive earnings have better capabilities than net profit in predicting future cash flows. According to the statement IAI (2017); FASB (2010),…”

“…Comprehensive income statements can be used to predict future cash flows of an enterprise (Kieso, Weygandt, and Warfield, 2014). Previous research conducted by Oleh Palea and Scagnelli (2016) and Kim and Kross (2005) proved that the accrual profit has a significant ability to predict future cash flows.…”

“…Jaweher and Mounira (2013) found that net profit has higher value relevance than comprehensive profit in explaining future cash flows and future profits. Palea and Scagnelli (2016) found that comprehensive income has better abilities than net profit in predicting future cash flows. The motivation of this research is to know the benefits of additional other comprehensive income information on net income to form a comprehensive profit in predicting future cash flows.…”

Compliance Over Time by Australian Firms with IFRS Disclosure Requirements

“…). However, the requirement has been included because it is important information for financial statement users to predict cash flow; and preparers are in a better position to predict cash flow than investors (Hope ; Palea and Scagnelli ). This is not a problem solely related to the initial adoption of A‐IFRS; it persisted even after 10 years of adoption.…”