Interactive Tutorial 6 Question 1: (a) Why might a companys operating profit in a particular period be different from its cash flow from operations? (b) Is cash flow more reliable than accounting profit? Which one is more useful? Answer: (a) Operating profit includes many non-cash items such as depreciation, amortization and provision. Operating profit also include many accrual items such as accrued salary and wages, accrued operating expenses etc, credit sales for which cash has not been received. Cash flow from operating activities does not include any such non-cash items or accrual items for which cash has not paid or received. Hence, the companys cash flows from is different from operating profit. (b) The argument that cash-flow data might be more reliable than profit-related data is based on the view that the determination of profits relies upon many professional judgments, such that different teams of accountants would rarely calculate the same profit or loss figure for the same entity. Profit can also be manipulated. By contrast, cash and cash equivalents are more objectively determined and less susceptible to manipulation. However, it is debatable whether cash-flow data is more relevant than profit-based data. This is a good opportunity to consider the issue of relevance versus representational faithfulness. Cash-flow data and accounting-profit data serve different purposes. Arguably, in assessing financial performance, accounting profits provide a superior measure. Profit takes into account the inflows and outflows of economic benefits. Cash flows only consider inflows and outflows of cash and cash equivalents. The flow of cash does not necessarily equate to inflow of net assets to an entity. For example, we may sell land for cash at a price equal to its carrying amount. Although there is an inflow of cash, the net assets of the entity would remain unchanged. Nevertheless, for determining the solvency and cash management of a reporting entity a statement of cash flows, and its supporting notes, is a useful complement to the statement of comprehensive income and statement of financial position.