Abstract
The aim of this study is to determine whether accruals have information value beyond that provided by isolated current cash flows for the prediction of future cash flows. Using a sample of 4,397 Spanish companies (mostly privately held), we estimate in-sample regressions of future cash flows on isolated current cash flows and on accrual-based earnings. We then find that the out-of-sample prediction errors provided by the accrual-based earnings model are significantly lower than those obtained with the cash flows model. We also regress the decrease in prediction errors brought about by the addition of accruals on a set of firm-specific circumstances where accounting manipulation is expected. In all cases the decrease in prediction errors is significantly affected in the hypothesized direction.
Highlights
The two main accounting standards boards (FASB 1978; IASB 1989) agree on the superiority of accrual-basis accounting over the cash basis to provide summary indicators of a firm’s performance
The role of accounting accruals for the prediction of future cash flows is bound to differ across public and private firms and, the former are likely to be more similar to Anglo-Saxon firms, most Spanish companies are privately held
We find that the role of accruals for the prediction of future cash flows is significantly moderated in firmspecific situations where managers are expected to make a more opportunistic use of accounting discretion
Summary
The two main accounting standards boards (FASB 1978; IASB 1989) agree on the superiority of accrual-basis accounting over the cash basis to provide summary indicators of a firm’s performance. Empirical evidence that earnings quality is significantly lower in countries with poor enforcement mechanisms (Leuz et al 2003) and especially in private firms (Burgstahler et al 2006) reduces confidence in the Spanish reporting model and calls for an empirical evaluation of the information content of accruals. This is, the primary purpose of our study. Our results are consistent with the argument that accruals add relevant information for the prediction of future cash flows, that is, that the prediction errors provided by an accrual-based earnings model are significantly lower than those obtained with isolated current cash flows.
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