Discussion of The Incremental Information Content of Accruals: Evidence Based on the Exponential Smoothing of Levels and Trends in Pre-tax Earnings, Funds Flow and Cash Flow (original) (raw)
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Accounting earnings and cash flows as measures of firm performance The role of accounting accruals
under which accruals are predicted to improve earnings' ability to measure firm performance, as reflected in stock returns. The importance of accruals is hypothesized to increase (i) the shorter the performance measurement interval, (ii) the greater the volatility of the firm's working capital requirements and investment and financing activities, and (iii) the longer the firm's operating cycle. Under each of these circumstances, cash flows are predicted to suffer more severely from timing and matching problems that reduce their ability to reflect firm performance. The results of empirical tests are consistent with these predictions.
Discussion of the Quality of Accruals and Earnings: The Role of Accrual Estimation Errors
The Accounting Review, 2002
Dechow and Dichev (2002) model earnings quality as the magnitude of estimation errors in accruals, and provide empirical estimates of this construct based on the relation between accruals and cash flows. I characterize the innovation and limitations in this approach, and provide empirical evidence of measurement error in their empirical specification. I also adapt their model to assess the specification of the Jones' (1991) model and document that this model provides estimates of discretionary accruals that are significantly associated with cash flows, which are likely to be substantially nondiscretionary. I conclude with suggestions for future research on earnings quality and earnings management.
International Journal of Economics and Financial Issues
This research founds the relative predictabilities of accruals and further disaggregated accruals-trading accruals, non-trading accruals, and financial accruals in the estimation of future cash flows. The research also examines the effect of the global financial crisis on this association between accruals and future cash flow prediction. The research uses annual data from the period of 1999 to 2018 from 453 firms, which includes 9060 observations. The whole sample period covers data from 1999 to 2018, during the financial crisis period from 2008 to 2009 and Pre financial crisis period from 1999 to 2007 and Post global financial crisis period 2010 to 2018. To examine the relationship between accruals, disaggregated accruals, and estimation of future cash flows, hypotheses were developed and seasoned through OLS. The outcomes confirm that financial accruals, non-trading accruals, and total aggregated accruals were significant, but trading accruals was not a significant contributor to the estimation of future cash flows. Moreover, there was no significant effect of the global financial crisis on the relationship among disaggregated accruals and forecast of imminent cash flows during Pre and Post and during the global financial crisis period.
The Role of Accruals in the Prediction of Future Earnings
Journal of Accounting and Finance, 2019
Although past accruals can explain current earnings, whether current accruals can predict future earnings has not been examined. I introduce three regression-based prediction models to predict future earnings: using only cash flows only, both cash flows and accruals, and earnings, to determine whether current accruals contribute to the prediction of future earnings. I find a cash flows and accruals model is more precise than a cash flows-only model, but the earnings model is the most precise. This result suggests that current earnings are a more accurate predictor of future earnings, and that accruals' persistence is less important in prediction of future earnings. I also document that predictions based on these models are more precise than time series-based predictions, but not as precise as analysts' forecasts. Additionally, I investigate how current earnings management negatively affects prediction of future earnings and hypothesize that current accrual management and real earnings management are positively associated with the prediction errors of the three models. The result shows that only the measure of real earnings management is positively associated with prediction error.
Recent empirical works have documented that stock prices do not fully reflect information in accruals and cash flows in predicting future earnings, following the findings of Sloan (1996) and Richardson et al (2005) who provide evidence of stock mispricing associated with accrual and reliability of accrual components in the US. The objective of this paper is to investigate whether stock prices fully reflect information contained in cash flow and accrual about future earnings in the UK. A sample of FTSE 350 non-financial firms listed on the London Stock Exchange is studied for the period 1980-2016. The results show that accruals are less persistent than cash flows, with less reliable accrual components having even lower persistence. The results for accrual pricing indicate that UK investors underestimate total accrual persistence information in their stock prediction. However, when total accruals are categorized based on their levels of reliability, UK investors accurately price low to medium accruals information embedded in future stock prices, but overestimate high reliability components of accruals.
The role of earnings management in the relationship between accruals and market value
Investment Management and Financial Innovations
The paper aims to clarify the role of earnings management in the relationship between accruals and the market value of companies. Previous studies suggest that some managers, for providing a desirable image of their performance, manage their profits through distorting cash or accruals. Consequently, investors rely on this information and estimate inaccurate stability of accruals which lead to mispricing phenomenon. Finally, the returns earned by the investors will not be equal to the expected return and thus the accrual anomaly will be created.To this aim, two hypotheses were developed and three regression models were applied to analyze the data. To analyze and estimate the models employed, the financial information of 110 companies listed on the stock exchange between years 2008 to 2014 is used. A selective approach to test the hypotheses is studying cross-sectional data.After conducting statistical tests, the results showed that discretionary accruals through which earnings manage...
Journal of Accounting, Auditing & Finance
I am delighted to have this opportunity to comment on Jerry Feltham and Jinhan Pae's paper, "Analysis of the Impact of Accounting Accruals on Earnings Uncertainty and Response Coefficients." Accruals constitute the heart of the system of accounting and financial reporting. It is accruals that distinguish accounting from mere counting of cash. Accrual accounting can be defined by the presence of liabilities and noncash assets on the balance sheet. Without accruals, there would be no liabilities and no assets except cash. Accruals require accountants to anticipate the future, and make difficult judgments about events that are uncertain and yet to occur. A greater part of accountants' professionalism consists of making these judgments. Many people who thought that accountants might be replaced by computers are surprised that 40 years later, no such substitution is in sight. While a large part of bookkeeping can be, and has already been, taken over by computers, determination of accruals has not, and cannot be, taken over by computers. In this sense, accruals are the essence of accounting. Which anticipations about the future should be included in the books of account and financial reports, and which ones should be deferred until a later date? Which ones are, in fact, included, and with what frequency? What are the consequences of different answers to these questions for the relationship between financial reports and security prices? These are critical issues that have been before managers, accountants, security analysts, and regulators for at least the past hundred years since the joint stock companies and stock and bond markets became an important part of the U.S. economy. With the explosion of derivative securities in the recent decades, triggered by the cheaper transaction technologies, these questions about accruals have become both more difficult as well as more important. I therefore look forward to research that promises new insights into the nature and consequences of accruals. For this reason, and knowing Professor Feltham's seminal contributions to accounting in the past, I accepted Professor Callen's invitation to discuss this paper with alacrity. 1 admit to being disappointed on the basis of what I have been able to understand of the paper. The paper opens with a reference to Feltham and Ohlson's 1996
Evidence of the Abnormal Accrual Anomaly Incremental to Operating Cash Flows
The Accounting Review, 2006
Recent research provides evidence that the operating cash flows-to-price ratio subsumes accruals in explaining future annual returns. This suggests that the accrual anomaly is part of the overall value-glamour anomaly and does not represent the mispricing of earnings. We extend the literature by using multiple measures of abnormal accruals and separate analyses of future annual returns and future earnings announcement returns. The results reveal that the operating cash flows-to-price ratio does not subsume abnormal accruals in explaining future annual returns or future announcement returns. We also find that the operating cash flows-to-price ratio does not subsume total accruals in explaining future announcement returns. These results are not consistent with accruals being a manifestation of the value-glamour anomaly. Our study contributes to the current debate on the existence and the extent of the (abnormal) accrual anomaly. Moreover, the methodology employed can help researchers ...
Accruals, Cash Flows, and Equity Values
Ssrn Electronic Journal, 1999
We find, as predicted, that the differential ability of accrual and cash flow components of earnings to help forecast future abnormal earnings and the persistence of the components result in the components having different valuation implications. We base our tests on Ohlson (1999) applied to fourteen industries. We find: (1) Accruals and cash flows aid in forecasting future abnormal earnings
The Quality of the Accruals , Return , and Direct Indicator of Cash Flow Shocks
2015
One of the most important factors in selecting the best investment is stock return. With regard to the relationship between stocks return and other accounting information, the investors can allocate their sources in the best way. The quality of accruals is one of the effective factors on the stocks return. This research aims to study the effect of the quality of accruals on the return and cash flow shocks of the stocks. The hypotheses of the research were examined by regression model using combined data and based on a pooled model and by a sample including 87 companies and 1044 observed cases from 2001 to 2012. The result indicated that there is no significant relationship between the qualities of the accruals and the excess return. Moreover, there is a positive correlation between the quality of the accruals and the cash flow shock.