On the Relation between Accruals and Cash Flows

Abstract

Research on corporate financial reporting identifies two important roles of accounting accruals. First, accruals smooth fluctuations in operating cash flows. Second, accruals allow recognition of losses in an asymmetric timely manner. While these two roles imply different relations between individual accruals and operating cash flow news, prior research often focuses on the properties of aggregate accruals. We investigate the role of individual accrual components and identify asymmetry in the relation of investment with operating cash flow news as a confounding factor in prior research. We show that this investment factor operates through depreciation and amortization accruals, which typically account for the bulk of aggregate accruals. Our granular approach challenges prior evidence of variation in asymmetric timeliness with firm size and sheds new light on the role of diminishing working capital intensity in explaining an overall declining trend in the smoothing role of accruals.