Classification Shifting in the Cash Flow Statement

• In Event: Financial Accounting and Reporting 1

Abstract

Prior evidence on classification shifting suggests that managers misclassify operating expenses as income-decreasing special items to inflate core earnings in the income statement (McVay 2006). There is limited empirical evidence (Lee 2012) on use of this manipulation and misclassification strategies in the cash flow statement. In this paper, we present large-sample evidence that managers of Indian firms manipulate operating cash flows using four different misclassification strategies. Specifically, they shift operating cash outflows to investing and financing cash outflows, and investing and financing cash inflows to operating cash inflows. Our findings suggest that on an average an Indian firm inflates approximately 260 million worth of operating cash flows every year. We also find that financially distressed firms are more likely to manipulate operating cash flows by engaging in the misclassification of cash flows.

Authors

• Neerav Nagar, Indian Institute of Management–Calcutta

• Kaustav Sen, Pace University