Accruals and prediction of future cash flows
Accruals and the Prediction of Future Cash Flows: evidence from China
Background
Predicting the company’s future cash flows is of high significance in accounting and finance areas alike, due to the fact that the ability of company generating cash flows substantially influences its securities value. For this purpose, Financial Accounting Standards Board (FASB) states that the primary objective of financial reporting is to provide information to help investors, creditors, and others in assessing the amount and timing of prospective cash flows (FASB 1978, para.37-39). In addition, FASB asserts that the information about earnings and its components in accrual accounting basis generally predicts future cash flows better than current cash flow (FASB 1978, para.44). The International Accounting Standards Board (IASB) agrees by maintaining that cash flow information in the cash flow statement, in conjunction with information from financial statements, can assess future cash flows (IASC 1992, para.13). From the critical accounting prospect, managers have substantial motive to opportunistically manipulate earnings if their remuneration schemes root in accounting performance ().Though it is argued that earnings can be a deficient predictor of future cash flows because high level of subjective judgment from managers is involved, accrual measures can alleviate the timing and matching problems in operations cash flows, by conducting revenue recognition and following matching principles. Furthermore, accruals are crucial in fulfilling the primary objective of financial reporting by enhancing relevance of prospective cash flows predictions, lowering costs arose from information asymmetries and promoting economic resources allocation (SFAC No1, FASB 1978).
Literature review and hypothesis development
One research stream further stated that disaggregating earnings into cash flow and accrual components will significantly improve the predictability of predicting future cash
Background
Predicting the company’s future cash flows is of high significance in accounting and finance areas alike, due to the fact that the ability of company generating cash flows substantially influences its securities value. For this purpose, Financial Accounting Standards Board (FASB) states that the primary objective of financial reporting is to provide information to help investors, creditors, and others in assessing the amount and timing of prospective cash flows (FASB 1978, para.37-39). In addition, FASB asserts that the information about earnings and its components in accrual accounting basis generally predicts future cash flows better than current cash flow (FASB 1978, para.44). The International Accounting Standards Board (IASB) agrees by maintaining that cash flow information in the cash flow statement, in conjunction with information from financial statements, can assess future cash flows (IASC 1992, para.13). From the critical accounting prospect, managers have substantial motive to opportunistically manipulate earnings if their remuneration schemes root in accounting performance ().Though it is argued that earnings can be a deficient predictor of future cash flows because high level of subjective judgment from managers is involved, accrual measures can alleviate the timing and matching problems in operations cash flows, by conducting revenue recognition and following matching principles. Furthermore, accruals are crucial in fulfilling the primary objective of financial reporting by enhancing relevance of prospective cash flows predictions, lowering costs arose from information asymmetries and promoting economic resources allocation (SFAC No1, FASB 1978).
Literature review and hypothesis development
One research stream further stated that disaggregating earnings into cash flow and accrual components will significantly improve the predictability of predicting future cash