Discussion of The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition

Abstract

The accrual process is central to financial accounting. Accruals adjust cash flows to reported earnings and form the building blocks for the balance sheet. Given the importance of accruals to financial accounting, it is surprising how sparse the modeling of the overall accrual process has been within the literature. Until recently, the state of the art empirical approach modeled total accruals as a function of the change in sales and property, plant, and equipment (PP&E) (Jones [1991]). Recently, working capital accruals have been more formally modeled as a function of firms' selling activity and past, present, and future operating cash flows (e.g., Dechow, Kothari, and Watts [1998], Dechow and Dichev [2002]). Ball and Shivakumar incorporate conditional conservatism, an important feature of the earnings process, into existing accruals models. Specifically, they recognize that accruals are expected to be an asymmetric function of firm performance, in which economic losses are captured by the accruals process in a more timely manner than gains. Their evidence documents a robust asymmetry in the relation between accruals and economic losses and gains, and demonstrates that accruals models that incorporate this asymmetry have superior explanatory power. The authors' innovation advances