The Daily Technical #146: Why are increases in accounts payable shown as an increase in cash flow?

Good morning. Welcome to the 146th edition of The Daily Technical.

Now, you’re here for one reason, so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
Explain the reasoning behind the principle of conservatism in accrual accounting.

The conservatism principle requires thorough verification and caution by accountants when preparing financial statements, which can lead to a downward measurement bias in their estimates.

Central to accounting conservatism is the belief that it's better to understate revenue or the value of assets than to overstate it (and the reverse for expenses and liabilities).

As a result, the risk of a company's revenue or asset values being overstated and expenses or liabilities being understated is minimized.

Common Mistakes

1. Incorrectly stating that both revenues and expenses are understated. Remember, the principle leads to understating revenues and assets, while expenses and liabilities may be overstated, minimizing the risk of inaccurate financial reports.

2. Missing the principle's benefit to stakeholders. Reinforce how conservatism safeguards investors and creditors by ensuring financial reports are not misleadingly positive.

TL;DR

• Conservatism emphasizes caution in financial reporting to prevent overstating assets/revenue and understating expenses/liabilities.

• Employs a downward measurement bias, erring on the side of caution to produce reliable, accurate financial statements.

• Minimizes risks of inflating financial health, protecting stakeholders from overly optimistic assessments.

• Focuses on vigilant, prudent judgment in financial estimations to ensure transparency and trustworthiness.

TODAY’S QUESTION
Why are increases in accounts payable shown as an increase in cash flow?

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