The CEO of High Tech International decides to change an accounting method at the

Question

The CEO of High Tech International decides to change an accounting method at the end of the current year. The change results in reported profits increasing by 5%, but the company's cash flows are not changed. If the Capital Markets are efficient then: A- the stock price will increase due to higher profits, B-the stock price will not be affected by the accounting change, C-the stock price will decrease because accounting method changes are not permitted under generally accepted accounting principles, D- the stock price will increase only if the accounting change will also result in higher profits in the next year. from marycamillam@gmail.com

Explanation / Answer

Solution

Investors do not care about the differences between profit calculated on the accrual basis and the cash basis. There is no correlation between the changes in the share prices and the differences between the financial results calculated in the profit and loss account and cash flow statement. Investors do not consider the differences between these results as an attempt to create artificial earnings. In case of such differences they do not sell off
shares. It could be argued that investors are aware of the shortcomings of accounting and are able to see them.

So, as per the above statement, option B that is the stock price will not be affected by the accounting change is the correct option.

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