Question

The income statement provides accrual based earnings and the cash flow statement provides cash flows from operations. Which of these measures of firm performance is more important to investors, auditors, and fraud investigators? Is it possible that one of these measures can provide clues about manipulation of the other? What are some red flags that could signal manipulation of income from operations or cash flows from operating activities?

Answer 1

The income statement provides accrual based earnings and the cash flow statement provides cash flows from operations. Which of these measures of firm performance is more important to investors, auditors, and fraud investigators.It's true fact.

Yes, it is possiable that one of these measure can provide clues about manipulation of the other.

Folllowing red some flag that could signal manipulation of income from operations or cash flows from operating activities

Operating cash flow can be distorted in several different ways:-

• Changing Accounts Payable:- Accountants have to determine when to recognize payments made by the company, which are recorded under accounts payable. Suppose a company writes a check and does not deduct that payable amount before the check is actually deposited, allowing the funds to be reported instead in operating cash flow as cash on hand. Another technique that a company might use involves paying overdrafts.
• Misusing Non-operating Cash:-Companies sometimes generate income from operations that are not related to their normal business activity, such as trading in the securities market. These are typically short-term investments and have nothing to do with the strength of the business's core model.
• Receivables and Cash Flow:-The working capital accounts are most directly responsible for the reporting of cash flow. Receivables increase cash flow, while accounts payable decrease cash flow. A company could artificially inflate its cash flow by accelerating the recognition of funds coming in and delay the recognition of funds leaving until the next period.

Look For These Red Flags In The Income Statement:-

• Beware of Revenue Manipulation:- evenues are vulnerable to misrepresentation. Common ways to manipulate revenues include recording revenue before it is actually earned or simply making up revenue that does not exist.
• Misrepresenting Expenses:- One common way of manipulating expenses is through inventory manipulation. For instance, a business could buy materials and then not record the full expense of the purchase or not record the purchase at all.
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