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Assessing the quality of reported earnings using cash flow data. Prior to the dominance of...

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Accounting

Assessing the quality of reported earnings using cash flow data. Prior to the dominance of Netflix, Blockbuster was the leading movie rental company in the U.S. In 1989, Lee J. Seidler, a senior analyst with Bear Stearns & Co., issued a research report critical of Blockbusters earnings. Mr. Seidler observed that although Blockbusters 1988 net income was $15.5 million and its cash flow from operating activities was $48.4 million, his review of the firms cash flow data revealed that Blockbusters purchases of new videocassette rental inventory had been classified as an investing activity rather than as operating activity on the companys statement of cash flows. Presented below is selected financial statement for Blockbuster (in millions of dollars): 1988 1987 Net Income $15.5 $4.09 Cash Flow from Operations 48.3 10.3 Purchases of videocassettes rental inventory (51.3) (14.3) Do you agree with Blockbusters decision to classify its videocassette inventory purchases as an investing activity? Why or Why not? How does Blockbusters cash flow classification of its video inventory purchases affect its cash flow from operations? In general, discuss how the statement of cash flow data can be used to help evaluate a companys reported earnings?

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