Companies have two options in disclosing their cash flows based on GAAP standards: the direct method (DM) and the indirect method (IDM). It has been argued that the former, which looks at such factors as cash received from customers, is too costly to justify its use in providing investors with additional information from which to predict future performance. As a result, 98 percent of firms today choose the indirect method for cash flow disclosures, according to Dr. Steven Orpurt who recently joined the Graziadio School of Business and Management at Pepperdine University as an Assistant Professor of Accounting.
However, that percentage may be changing.
When members of the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board met for a joint meeting last October, the conversation turned to a research study co-authored by Dr. Orpurt and his former colleague from Singapore Management University, Dr. Yoonseok Zang. The study, entitled Do Direct Cash Flow Disclosures Help Predict Future Operating Cash Flows and Earnings?, concluded that the direct method is informative to investors (incrementally to the IDM) when forecasting future cash flows and earnings. The research was based on sample data from 119 firms and more than 600 cash flow statements spanning 13 years.
According to Dr. Orpurt, there has been a strong push among the analyst and investor communities to require direct method reporting believing it provides more transparency about a company’s operations. “There were a lot of constituents that wanted the direct method back in 1988, along with the FASB itself, and it was the firms themselves that said it would be difficult to produce. They weren’t sure if investors would use the information,”
With little research conducted in this area, Dr. Orpurt and his co-author sought to fill in a missing piece – concrete analysis delineating the informational value of DM disclosures. He hopes his study will help FASB members decide whether the direct method provides cost effective information useful to investors and others using financial statements. That question will likely be put in front of the board for a vote.
In the meantime, Dr. Orpurt will continue incorporating accounting research into his classes. “Research belongs in classes, and there is a substantial amount of research in accounting,”
Dr. Orpurt currently teaches in the Full-time MBA and Fully Employed MBA programs. He previously taught courses at Northwestern University, Boston University, and, for the last five years, Singapore Management University. His research and teaching interests include capital market valuation, financial statement analysis, and financial accounting. He was a volunteer instructor with aidha, a nonprofit organization based in Singapore that provides women migrant workers– primarily domestic helpers – with assistance in planning for their financial future. He is now contributing to that organization’
