The Effects of Financial Statement and Informational Complexity on Cash Flow Forecasts

The Accounting Review, Vol. 83, No. 4, pp. 915-956, 2008

53 Pages Posted: 26 Jan 2007 Last revised: 13 May 2014

See all articles by Leslie D. Hodder

Leslie D. Hodder

Indiana University - Kelley School of Business - Department of Accounting

Patrick E. Hopkins

Indiana University - Kelley School of Business - Department of Accounting

David A. Wood

Brigham Young University - School of Accountancy

Date Written: December 23, 2006

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.

Keywords: analysts, cash flows, forecasting, complexity, judgment and decision making

JEL Classification: G12, G29, M41, M44, C91

Suggested Citation

Davis Hodder, Leslie D. and Hopkins, Patrick E. and Wood, David A., The Effects of Financial Statement and Informational Complexity on Cash Flow Forecasts (December 23, 2006). The Accounting Review, Vol. 83, No. 4, pp. 915-956, 2008, Available at SSRN: https://ssrn.com/abstract=953454

Leslie D. Davis Hodder (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Patrick E. Hopkins

Indiana University - Kelley School of Business - Department of Accounting ( email )

Kelley School of Business
1309 E. 10th Street
Bloomington, IN 47405
United States
812-855 2617 (Phone)
812-855 8679 (Fax)

David A. Wood

Brigham Young University - School of Accountancy ( email )

518 TNRB
Brigham Young University
Provo, UT 84602
United States
801-422-8642 (Phone)
801-422-0621 (Fax)

HOME PAGE: http://marriottschool.byu.edu/employee/employee.cfm?emp=daw44

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