The decision usefulness of reported cash flow and accrual information in a behavioural field experiment

Abstract

While recent capital market studies tend to reveal some information content in cash flows, their results may not be generalisable to other contexts such as the assessment of solvency. Mandated accounting standards on cash flow emphasise the relevance of cash flow data for assessing solvency. However, there is a paucity of research that specifically investigates this contention. Accordingly, this study investigates the decision usefulness of reported cash flow and accrual information in a behavioural field solvency assessment experiment. Using a two-group between-subjects field experiment design, bankers with at least three years corporate lending experience made solvency judgments using either cash flow cues or accrual cues. We found that, as hypothesised, judgments based on cash flow information were more accurate than judgments based on accrual information. The difference in judgment accuracy was more pronounced for insolvent (failed) companies than for solvent (non-failed) companies. This observation suggests that cash flow information is more decision useful for firms experiencing financial distress. Our results therefore imply that cash flow information has greater decision usefulness than accrual information for assessing corporate solvency and support the mandate of the Stcireaienf qj'CLisk Nows. Our results also support the normative arguments of proponents of cash flow reporting.

Ability of Combinations of Cash Flow Components to Predict Financial Distress

“…Among the important researches that have been done about prediction of financial distress and bankruptcy are: Beaver (1966), Largay III and Stickney (1980), Gentry, Newbold and Whitford (1985), Gilbert, Menon and Schwartz (1990), Schellenger and Cross (1994), Sharma and Iselin (2003) Turetsky and Mcewen (2001).…”

Misclassifying cash flows from operations: intentional or not?

“…Academics have long advocated the importance and usefulness of the statement of cash flows (Gup and Dugan, 1988;Hodgson and Stevenson-Clark, 2000;Hossain et al, 2011;Jones, 1998;Purr, 2004;Sharma and Iselin, 2003). The statement of cash flows is unique from other financial statements because it is relatively free from bias.…”

“…The statement of cash flows is unique from other financial statements because it is relatively free from bias. Other studies support this perspective, arguing cash flow information to be as, or more useful, than accrual information for decision-making (Jones and Widyaya, 1998;Sharma and Iselin, 2003). However, recent examinations question the quality and clarity of information in the statement of cash flows; arguing it is not clear nor conducive to providing the information investors require, as classifications are poorly defined and not necessarily consistent (Broome, 2004;Hill et al, 2003).…”

The informational impacts of Australian listed companies reporting the direct or indirect method statement of cash flows: cash flow disclosure

“…Accounting standards highlight the importance of firms providing cash flow data for assessing company solvency (Sharma and Iselin, 2003). In an experimental setting using bankers with at least three years' experience, judgements based on cash flows were more accurate at predicting insolvent companies (failed companies) than judgements based on accruals (Sharma and Iselin, 2003).…”

“…In an experimental setting using bankers with at least three years' experience, judgements based on cash flows were more accurate at predicting insolvent companies (failed companies) than judgements based on accruals (Sharma and Iselin, 2003). The advantage of the cash flow statement is that is does not rely on relatively unambiguous allocations of performance and is less subject to distortion (Sloan, 1996;Jones, Romano and Smyrnios, 1995).…”