INTEGRATING EARNINGS AND C F PER C Sds4-17-0510pt

INTEGRATING EARNINGS AND C F PER C Sds4-17-0510pt -...

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INTEGRATING EARNINGS AND CASH FLOWS PER COMMON SHARE Kenneth E. Stone, Ph.D. Professor of accounting Ronald D. Niemeyer, Ph.D. Professor of Accounting Harmon College of Business Administration Department of Accounting Central Missouri State University Dockery 400 Warrensburg, MO 64093 Phone: 660-543-4631 Fax: 660-543-8465 E-Mail: kstone@cmsu1.cmsu.edu April 23, 2005 1
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INTEGRATING EARNINGS AND CASH FLOWS PER COMMON SHARE ABSTRACT Reporting cash flows per share is not currently allowed under Generally Accepted Accounting Principles (GAAP); however, financial analysts and other financial statement users have been computing their own cash flows figures and using them in various analytical models to evaluate the financial health of companies. Cash flows per share should not be misleading if they are clearly reconciled with basic Earnings per Share (EPS). Furthermore, if this reconciliation data is horizontally analyzed over several years, additional insights into the financial activities of the company may be revealed. The accounting profession cannot continue to ignore the reporting of cash flows per share because this information is desired by investors and is already being used. Continuing to ignore cash flows per share reporting causes the accounting profession to appear resistant to change and out of touch with reality. This appearance also erodes the credibility of financial accounting. INTRODUCTION Reporting cash flows per common share is currently not allowed under Generally Accepted Accounting Principles (GAAP). Investors and financial analysts appear to be very interested in the earnings per share (EPS) figures (basic and diluted), which indicates that EPS contains significant information. Earnings per share is based on accrual accounting net income that is subject to various selections, judgments, estimates and assumptions. Alternatively, cash flows are not subject to as many variations or methods of manipulation as net income. Other than fraudulent reporting, cash flows can be manipulated only by erroneous classifications and the timing of transactions. Several researchers have concluded there is substantial information in a reported cash flow per share (for example, Detman 2003 and Lee et al. 1999). Therefore, the following topics are discussed: (1) the possible composition of cash flows per share to be reported; (2) comparison of basic earnings per share and cash flows per share, and (3) reconciliation of basic earnings per share reported on the income statement with various cash flows per share that could be reported on the statement of cash flows. Recommendations are made for the reporting of cash flows per common share. 2
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REVIEW OF RELATED LITERATURE Belkaoui (1983) discusses the differences between accrual accounting and cash accounting. A study comparing the relative merits of earnings per share, common stock equity per share, and operating cash flows per share was conducted. The relationship of these figures to the market price of the stock indicates that both common
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INTEGRATING EARNINGS AND C F PER C Sds4-17-0510pt -...

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