Accrual income statements and present value models

Abstract

PurposeThis paper demonstrates that present value (PV) models can be viewed as multiperiod extensions of accrual income statements (AISs). Failure to include AIS details in PV models may lead to inaccurate estimates of earnings and rates of return on assets and equity and inconsistent rankings of mutually exclusive investments. Finally, this paper points out that rankings based on assets and equity earnings and rates of return need not be consistent, requiring financial managers to consider carefully the questions they expect PV models to answer.Design/methodology/approachAISs are used to guide the construction of PV models. Numerical examples illustrate the results. Deductions from AIS definitions demonstrate the potential conflict between asset and equity earnings and rates of return.FindingsPV models can be viewed as multiperiod extensions of AISs. Mutually exclusive rankings based on assets and equity earnings and rates of return need not be consistent.Research limitations/implicationsPV models are sometimes constructed without the details included in AISs. The result of this simplified approach to PV model construction is that earnings and rates of return may be miscalculated and rankings based as asset and equity earnings and rates of return are inconsistent. Tax adjustments for asset and equity earnings may be miscalculated in applied models.Practical implicationsThis paper provides guidelines for properly constructing PV models consistent with AISs.Social implicationsPV models are especially important for small to medium size firms that characterize much of agricultural. Providing a model consistent with AIS construction principles should help financial managers view the linkage between building financial statements and investment analysis.Originality/valueThis is the first paper to develop the idea that the PV model can be viewed as a multiperiod extension of an AIS.