Asset Conversion Cycle and Accruals Persistence

Abstract

We examine the relationship between the persistence of the accrual component of earnings and asset conversion cycle, i.e., the speed of accrual reversal. We argue that, as all accruals have to ultimately reverse, those reversing at a slower speed will exhibit more persistence. We use the operating cycle and investment cycle to measure the reversal speeds of working capital accruals and noncurrent accruals, respectively. Our results show that the investment cycle is positively associated with the persistence of noncurrent accruals. However, the operating cycle does not affect the persistence of working capital accruals, because by definition these accruals will reverse within one year. In addition, we find that analysts do not fully understand the effects of asset conversion cycles especially for long-horizon forecasts. Collectively, our study suggests that the lower persistence of accruals is not all attributable to estimation errors, and the asset conversion cycle is an important determinant of accrual persistence.