Accounting Questions

 “The accounting profit and cash generated must be the same for a company.”. Do you agree with this statement? Why or why not?

No.

To be able to understand the reason for disagreeing with the above statement, it is imperative to consider the key difference between the two concepts. As pointed out by Stobierski (2020), the key difference is that while profit is an indication of the amount a company has left after incurring all expenses, cash flow is an indication of the net flow of cash that comes into and out of the company. In view of the above, it is clear that cash flow cannot necessarily equal profitability and vice versa (King, n.d.).

There are two major reasons for this. First is that companies can sometimes make use of cash items that do not appear on the income statement (Hofstrand, 2022). The second issue is the case of the accrual accounting method, which is the time difference between when revenues and expenses are recognised in the book as against when they were actually collected and paid. Thus, critical assessment of these factors clearly indicates that cash flow and profitability of a company will likely not be the same (CFI Team, n.d.).

Even holding the above two factors constant, cash will still not necessarily equal profitability because sometimes a company can be making so much money but still be unprofitable due to numerous expenses it will need to incur. For instance, if a company was established with a loan or had borrowed money to run its business, the implication is that the company will have to repay the money with the cash inflow coming into its income statement. Therefore, while the company might be generating cash flow, these cash will be used for repaying borrowed money, and the company will essentially be in loss instead of profit. There are also cases where a company reduced the price of its products in order to clear old stock or penetrate the market, and the implication becomes that it will be making losses even with heavy cash flow. Thus, cash does not equal profitability in a company (Beers, 2024).

“Financial statement should be free from all misstatements”. Discuss the validity of this statement

Generally, financial statements are critical tools used in decision-making, whether it is by the stakeholders (including investors), creditors, or other regulatory bodies. Therefore, the statement that “financial statements should be free from all misstatements” is a clear reflection of the basic principles of reliability, accuracy, and transparency that are essential in financial reporting (ACCA, n.d.). Nevertheless, although the goal is to make sure that financial statements are free from misstatements, practical limitations actually make it extremely difficult to attain absolute accuracy (Trullion, 2024).

In financial statements, misstatements can come in two forms: fraudulent misstatements—those that were intentionally made—and errors—those that are considered unintentional mistakes (FRC, 2023). As mandated by International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), financial statements should be made in such a way that they offer a fair and true perspective of the company’s financial position. On the same note, auditors have a crucial role in ensuring that material misstatements are detected and prevented through their audit procedures (PCAOB, 2017).

Notwithstanding these efforts, it is still possible for financial statements to contain immaterial misstatements as a result of judgemental differences, estimation errors, or limitations inherent in the accounting processes (PWC, 2017). For instance, accounting principles like fair value estimates, depreciation methods, and provisions that are based on management assumptions can introduce uncertainty and subjectivity. Going further, it is also possible for fraudulent activities to bypass internal controls, and this will make it extremely difficult to entirely eliminate all misstatements.

To conclude the above argument, although it is essential to ensure that financial statements are made as accurate as possible, it is still unrealistic for one to expect them to be entirely free of misstatements. Thus, the central objective is to make sure that any misstatement made does not materially mislead the stakeholders, with a focus on how the company should uphold financial integrity and trust within its corporate reporting (ICAEW, n.d.).

References

ACCA (n.d.) ‘ISA 450 – Objectives and definitions’, Association of Chartered Certified Accountants (ACCA). Available at: https://www.accaglobal.com/africa/en/student/exam-support-resources/professional-exams-study-resources/p7/technical-articles/misstatements.html (Accessed: 07-03-2025).

Beers, B. (2024) ‘What’s more important, cash flow or profits?’, Investopedia, 23 April. Available at: https://www.investopedia.com/ask/answers/111714/whats-more-important-cash-flow-or-profits.asp (Accessed: 07-03-2025).

CFI Team (n.d.) ‘Profit vs cash: learn more about the two key finance terms’, Corporate Finance Institute. Available at: https://corporatefinanceinstitute.com/resources/accounting/profit-vs-cash/ (Accessed: 07-03-2025).

FRC (2023) ‘Auditor’s responsibilities for the audit’, Financial Reporting Council (FRC), 24 September. Available at: https://www.frc.org.uk/library/standards-codes-policy/audit-assurance-and-ethics/auditors-responsibilities-for-the-audit/ (Accessed: 07-03-2025).

Hofstrand, D. (2022) ‘Cash flow and profitability are not the same’, Iowa State University Extension and Outreach, March. Available at: https://www.extension.iastate.edu/agdm/wholefarm/html/c5-213.html (Accessed: 02-07-2025).

ICAEW (n.d.) ‘Materiality in the audit of financial statements’, Institute of Chartered Accountants in England and Wales (ICAEW). Available at: https://www.icaew.com/technical/audit-and-assurance/audit/risk-assessment-internal-control-and-response/materiality-in-the-audit-of-financial-statements (Accessed: 08-03-2025).

King, S. (n.d.) ‘Why profits don’t equal cash flow’, GrowthForce. Available at: https://www.growthforce.com/blog/why-profits-dont-equal-cash-flow (Accessed: 07-03-2025).

PCAOB (2017) ‘AS 3101: The auditor's report on an audit of financial statements when the auditor expresses an unqualified opinion’, Public Company Accounting Oversight Board (PCAOB). Available at: https://pcaobus.org/oversight/standards/auditing-standards/details/AS3101 (Accessed: 07-03-2025).

PwC (2017) ‘Understanding a financial statement audit’. Available at: https://www.pwc.com/im/en/services/Assurance/pwc-understanding-financial-statement-audit.pdf (Accessed: 07-03-2025).

Stobierski, T. (2020) ‘Cash flow vs. profit: what’s the difference?’, Harvard Business School Online, 21 April. Available at: https://online.hbs.edu/blog/post/cash-flow-vs-profit (Accessed: 07-03-2025).

Trullion (2024) ‘Financial statement review: The comprehensive guide’, Trullion Blog, 8 April. Available at: https://trullion.com/blog/financial-statement-review-the-comprehensive-guide/ (Accessed: 07-03-2025).