Do Direct Cash Flow Disclosures Help Predict Future Operating Cash Flows and Earnings?

Accounting Review, May 2009

Posted: 22 Dec 2008

See all articles by Steven F. Orpurt

Steven F. Orpurt

Arizona State University; Singapore Management University

Yoonseok Zang

Singapore Management University - School of Accountancy

Abstract

Motivated by recent FASB, IASB, and CFA Institute comments, we explore the predictive value of direct method cash flow disclosures. A primary stated purpose of the direct method is to better forecast future performance. To examine this purpose, we first document that direct method line items such as cash received from customers are not reliably estimable using income statements and either balance sheets or indirect method statements of cash flows. When these estimation (articulation) errors are included in cash flows and earnings forecasting models, forecasting performance significantly improves. In addition, employing a FERC (future ERC) methodology, we find evidence suggesting that market participants utilize direct method disclosures for their stated purpose: to better forecast future operating performance. After conducting several tests for self-selection concerns, we conclude that the direct method is valuable to investors when forecasting future cash flows and earnings.

Keywords: Statement of cash flows, direct method, forecasting future cash flows and earnings, future earnings response coefficient (FERC), stock price informativeness

JEL Classification: M41, D82, D84

Suggested Citation

Orpurt, Steven F. and Zang, Yoonseok, Do Direct Cash Flow Disclosures Help Predict Future Operating Cash Flows and Earnings?. Accounting Review, May 2009. Available at SSRN: https://ssrn.com/abstract=1319102

Steven F. Orpurt (Contact Author)

Arizona State University ( email )

300 Lemon Street
PO Box 873606
Tempe, AZ 85287-3606
United States
480 965 2393 (Phone)

Singapore Management University ( email )

Li Ka Shing Library
70 Stamford Road
Singapore 178901, 178899
Singapore

Yoonseok Zang

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

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