Accrual Components Research Articles

PERSISTENCE, VALUE RELEVANCE, AND ACCRUALS QUALITY IN EXTREME EARNINGS AND CASH FLOW SITUATIONS

ABSTRACT Purpose: To analyze the impact of extreme earnings and cash flows on the persistence, value relevance, and accruals quality of Brazilian public firms. Originality/gap/relevance/implications: The present study contributes to the literature by analyzing extreme earnings and cash flows. Because they change the results of the period in which they occur in an unusual manner, this study suggests that studying their behaviors and impacts on the quality of the information disclosed by companies tends to contribute to optimal decision making in the capital market. Key methodological aspects: The analyzed sample comprised non-financial public companies traded on the BM&FBovespa stock exchange from 2005 to 2014, with estimates made using quantile regression. Summary of key results: The main results indicate that cash flows are more persistent than earnings because the accruals component of the latter makes them less persistent. Extreme values of both earnings and cash flows affect the persistence of these variables, with a strong and negative effect on cash flows. Finally, extreme values of accruals negatively affect accruals quality because, compared to moderate quantiles, they significantly alter the standard deviation of extreme quantiles. Key considerations/conclusions: The presence of extreme values in this study's focus variables negatively influenced market information quality, reducing its predictive power and, consequently, its relevance. Furthermore, controlling for extreme values, it was possible to observe the incremental information content of these two metrics.

PENGARUH EARNINGS, CASH FLOW FROM OPERATIONS, WORKING CAPITAL FROM OPERATIONS, DAN ACCRUAL COMPONENTS TERHADAP FUTURE CASH FLOW PADA PERUSAHAAN MANUFAKTUR YANG TERDAFTAR DI BURSA EFEK INDONESIA

The purpose of this study was to obtain empirical evidence about the effect of earnings, cash flow from operations, working capital from operations, and accrual components to future cash flow in manufacturing companies listed in Indonesia Stock Exchange. The samples used were 165 manufacturing companies listed in Indonesia Stock Exchange during 2010-2012. Data analysis was performed with the aid of a software program Statistical Product and Service Solutions (SPSS)for Windows. The results showed that earnings, cash flow from operations, and working capital from operations have an influence on future cash flow, while accrual components does not have any influence on future cash flow.

What Kind of Earnings Shape More Market Expectations?

We study how earnings attributes affect investors expectations about future earnings reflected in market prices. We separate the contribution of current earnings to price setting through a valuation incorporating expectations informed only by the current value of earnings. Its pricing error measures the extent to which expectations are shaped by information other than current earnings. We estimate the association between this pricing error and eleven earnings quality constructs commonly used in the empirical literature using a large sample of US non-financial firms over the period 1971-2014. We find that, above all, quality earnings vary little (are sustainable) and are predictive of future earnings. Moreover, their low volatility is shared by their accrual component and is not due to aggressive smoothing. We document that time-series accrual quality proxies subsume measures based on popular residual accruals models in shaping expectations. How often firms report special items has a significant impact on current earnings relevance to expectation formation: the less often, the better.

Implications of Firms Having Both Highly Negative Accruals and Cash Flows for Test of Accruals Anomaly

SYNOPSISThis study provides evidence that the weak (asset-deflated) accruals anomaly is attributable to firms having both highly negative accruals and cash flows. These firms yield highly negative future stock returns, which weakens the accruals anomaly by depressing overall future stock returns of the lowest accruals portfolio while reinforcing the cash flows anomaly. Among accruals components, accounts payable, depreciation, and non-current accruals capture their declining economic fundamentals and drive away the accruals anomaly. Additionally, we document that firms having both highly negative accruals and cash flows can account for the nonexistence of the accruals anomaly for loss firms, and reconcile the weak asset-deflated accruals anomaly with the robust earnings-deflated accruals anomaly (i.e., percent accruals). Overall, our findings suggest that implications of negative accruals depend on the level of cash flows, and a small subset of firms having both highly negative accruals and cash flows may distort the results of accruals anomaly tests.

KEMAMPUAN AKRUAL DAN ARUS KAS MEMPREDIKSI HARGA SAHAM MELALUI PERSISTENSI LABA

The objective of research seems to examine the effect of accrual and cash flow components in predicting earnings persistence. Research also aims at observing the effect of earnings persistence on stock prices, understanding the effect of accrual and cash flow components in predicting stock prices through earnings persistence. Hypotheses test considers contextual model and path analysis to connect the models in manner of causality. Research population includes manufacturing companies listed at Indonesia Stock Exchange in the financial reporting period 1999-2007. Judgment sampling criteria has been used to produce 51 companies with 5 observations for each company, resulting in data pooling of 255 companies. Empirical two model examination produces the probability of significant effect on endogenous variable, which is earnings persistence and stock prices. Individually, accrual and cash flow components have significant effect in predicting earnings persistence, earnings persistence as sustainable earnings prospect have shown significant effect on stock prices. The examination against accrual component ability in predicting stock prices indicates the coefficient of earnings persistence path as a significant mediator. The observation against cash flow component ability in predicting stock prices, however, does not show the coefficient of earnings persistence path as the significant mediator

Further evidence of the relationship between accruals and future cash flows

AbstractFocusing only on operating accruals in accrual‐based studies results in a loss of information and noisy measures of both accrual and cash flow components of earnings. Thus, we examine the relative importance of working capital accruals, non‐current operating accruals, and financing accruals with regard to future cash flows from operations (CFO). Using Australian data, we provide evidence that both working capital and non‐current operating accruals are important for explaining future CFO but that the contribution of financing accruals is not significant. Moreover, the asset component of accruals plays a more important role in explaining future CFO than the liability component.

Detecting Earning Management of Companies Listing on HOSE

The study is aimed to detecting earning management from companies listing in Ho Chi Minh Stock Exchange (HOSE) during the period from 2013 – 2015 by using 2 models, Jones (1991) and Modified Jones Model developed by Dechow et al. (1995). Moreover, we also tested the effectiveness of Jones (1991) for detecting firms’ earning management since prior researches showed that Jones (1991) has lower standard error in detecting accruals based earning management compared with other models as suggested by DeAngelo et al. (1994). Hence we proposed that Jones (1991) provides a more significant outcome for estimating the nondiscretionary component of accruals and thus less exposed to misspecifications error from absent variables. We found that Jones (1991) illustrates a better explainable ability even though the adjusted R-square of the models is closely similar with each other.

Source of IPOs’ Underperformance – Evidence on the Implication of Accrual Reversal

IPOs’ long-run underperformance has been well documented in prior studies. This paper examines earnings management and the implication of accrual reversals as the source of IPOs’ underperformance. I decompose earnings reported at the time of IPOs into accrual and cash components. I find that for US IPOs, only the cash component of earnings (not the accrual component) has significant predictive power for future stock performance; suggesting the level of accruals that makes up IPO earnings fails to sustain its performance in the post-issue period. For ADR IPOs, both the accrual and the cash components have significant predictive power for future stock performance. I further investigate whether the level of accrual reversal is associated with stock return in the post-issue period after controlling for earnings change. In the period subsequent to IPOs, after controlling for earnings change, I find that for US IPOs the larger the accrual reversal, the lower the stock performance. This result suggests that IPOs with inflated earnings are over-valued at the time of first going public. In the subsequent periods when accrual reversed against earnings, market penalizes firms with accrual reversal by revising their price valuation. For ADR firms, there is no significant association between accrual reversal and stock returns after controlling for earnings change, suggesting any change in accruals is due to changes in firm performance.

Industry contagion effects of internal control material weakness disclosures

This study examines whether there is an industry contagion effect for negative market reactions to internal control material weakness (ICMW) disclosures. From a sample of companies experiencing market share price declines to disclosures of ICMW over the years 2005–2014, results indicate that peer industry companies also experience market share price declines. We also find that the decline in share prices is related to accounting quality in that peer industry companies with higher accrual, relative to cash flow, components of earnings have larger negative market reaction compared to companies with lower accrual components of earnings. Our study contributes to the literature streams examining accounting information transfer and internal control quality.Data availability: Data are publicly available from sources identified in the paper.

The predictive power of investment and accruals

We test whether investment explains the accrual anomaly by splitting total accruals into investment-related and “nontransaction” accruals, items such as depreciation and asset write-downs that do not represent new investment expenditures. The two types of accruals have very different predictive power for firm performance, not just for future earnings but also for future cash flow and stock returns. Most importantly, nontransaction accruals have the strongest negative predictive slopes for earnings and stock returns, contrary to the predictions of the investment hypothesis. A long-short portfolio based on nontransaction accruals has a significant average return of 0.71 % monthly from 1972 to 2010 and remains profitable at the end of the sample when returns on other accrual strategies decline. Our results suggest that nontransaction accruals are the least reliable component of accruals and show that a significant portion of the accrual anomaly cannot be explained by investment.

Accrual Effect on Karachi Stock Exchange

The study examine whether the stock prices can reflect the information of future earnings contained in the accrual components of the current period. The magnitude of accruals component determines the extent to which the current earnings performance persists in the future. However, the current earnings show that the investors hardly reflect the information contained in the accruals components. All listed and non-listed companies (662) on Karachi Stock Exchange, form January 1993 to December 2015 are incorporated in the study. The study concluded that accruals anomaly does not exist in the Karachi Stock Exchange. Which implies that an investor who follows an investment strategy on the basis of accruals will not earn excess returns. Moreover, it implies the Capital Asset Pricing Model is a valid model to capture the effect of accruals.

Audit Quality And Accrual Reliability: Evidence From The Korean Stock Market

This study empirically investigates whether a high-quality audit improves the reliability of the components of total accruals using earnings persistence and cash flow predictability. I find that, for firms audited by Big Four auditors, their current or noncurrent assets-related accruals, which are less reliable (“more subjective in measurement”), lead to higher earnings persistence and future cash flow predictability than those of firms audited by non-Big Four auditors. These results suggest that high-quality auditors more effectively evaluate the reasonableness of accrual measurement based on more sufficient and appropriate audit evidence, leading to enhanced accrual reliability.

Accruals and price crashes

I investigate the relation between accruals and firm-level price crashes, representing extreme price decreases in weekly returns. I find that high accruals predict a higher price crash probability than low accruals. This finding can be explained by managers’ use of income-increasing accrual estimates to hoard bad news. Once accumulated bad news crosses a tipping point, it is released all at once and results in a price crash. Consistent with this explanation, I find the observed relation to be the strongest for operating assets (the least reliable accrual components). Cross-sectional analyses further support the bad news hoarding explanation.

The Usefulness Of The Tax Avoidance Proxy: Evidence From Korea

This study aims to verify the usefulness of the tax avoidance proxy developed by Desai and Dharmapala (2006) in the setting where accounting-tax alignment is relatively high and aggressive tax planning is restricted. By using a large set of firms in Korea, I empirically test whether the tax avoidance proxy detects the management of book-tax and book-only accruals. My findings show that downward management of book-tax accruals for tax reporting purposes is not detected by the tax avoidance proxy. However, upward management of book-only accruals for financial reporting purposes is captured by the tax avoidance proxy. In addition, the tax avoidance proxy better detects simultaneous management of two accrual components than management of book-tax accruals alone. Lastly, the tax avoidance proxy is more powerful in detecting tax avoidance activities in a sample of firms with high tax and financial reporting costs than in firms that carry high tax costs but low financial reporting costs. The results of this study imply that the tax avoidance proxy can be a good indicator only when used for firms that are conscious of their financial reporting costs and have incentive to manage both taxable and book income at the same time under the setting where book-tax conformity is high and aggressive tax shelters are restricted. This study sheds light on the usefulness of the tax avoidance proxy which has been widely used in the accounting studies and provides a caveat to researchers that the proxy should be employed with caution and in appropriate setting.

Implications of the cash component of earnings for earnings persistence and stock returns

The main objective of this paper is to examine the persistence, pricing and economic significance of the cash component of earnings in U.K. listed firms from 1981 to 2013. In so doing, we break down the cash component of earnings into changes in the cash balance and into issuances/distributions to debtholders and equity holders. We find that the cash component of earnings is more persistent than the accrual component and that this higher persistence can be attributed primarily to cash distributed to equity holders. Cash retained by the firm as changes in the cash balance also appears to be more persistent than accruals, whereas cash attributed to debtholders has approximately the same persistence level as accruals. The results from our pricing models support the naïve investor hypothesis and show both that future stock returns have the strongest positive correlation with the most persistent cash subcomponent of earnings and that investors can devise a profitable investment strategy by investing in companies that have high cash distributions to equity holders. Our results are consistent across subperiods – when controlling for changes in financial reporting standards and the economic environment – and across different size groupings.

Temporal variation and cross-sectional differences of accounting conservatism in emerging countries

Prior research finds that accounting conservatism has increased over time in developed countries. In this paper, we examine the time-series extent and shift of accounting conservatism in emerging countries over the period 2000-2012. We also analyse differences in conservatism level across countries, regions, legal regimes and industries. In addition, we examine the impact of size, market-to-book and leverage on the degree of conservatism at firm level. We use a set of measures to assess the degree of conservatism. These include changing time-series properties of profitability, earnings, cash flows, accruals components, asymmetric timeliness, Market-to-Book ratio and Khan and Watts' (2009) C-score. We find that the degree of conservatism declined during the period between 2000 and 2007 and increased over the period 2007-2012. In addition, we find significant differences in accounting conservatism between common-law and code-law countries, across regions and industries.

Crashes and Jumps in Price and Earnings: The Role of Accruals

I investigate the relation between accruals and firm-level price crashes, representing extreme price decreases in weekly returns. I find that high accruals predict a higher price crash probability than low accruals. This finding can be explained by managers’ use of income-increasing accrual estimates to hoard bad news. Once accumulated bad news crosses a tipping point, it is released all at once and results in a price crash. Consistent with this explanation, I find the observed relation to be the strongest for operating assets (the least reliable accrual components). Cross-sectional analyses further support the bad news hoarding explanation.

Comparing US-GAAP and Iran-GAAP operating cash flows to predict future cash flows

Purpose – The main objective of this paper is to compare the ability of US-generally accepted accounting principles (GAAP) operating cash flows versus Iran-GAAP operating cash flows in predicting future cash flows. Design/methodology/approach – The sample comprises 240 firms (1,200 firm-years) during the period from 2004 to 2008 for which operating cash flows and other variables are available. Cross-sectional and panel data regression models are used in testing the hypotheses. Findings – This study finds that operating cash flows based on Iran-GAAP are no more effective in predicting future cash flows than those based on USA-GAAP, and the predictive ability of the model is improved by adding the earnings accrual components to the operating cash flows. Originality/value – The study suggests that the Iranian accounting standard setting committee recommends that the statement of cash flows be prepared based on the three-category model instead of the five-category model in an attempt to converge with the International Financial Reporting Standards. Consistent with Financial Accounting Standards Board and financial analyst recommendations, the results reveal that earnings are a better predictor than cash flows from operations.

The accrual anomaly in Europe: The role of accounting distortions

Numerous studies claim that the accrual anomaly in the U.S. stock market is due mostly to temporary accounting distortions arising from accrual accounting. We examine the validity of this explanation in an international setting. Across the 15 developed European equity markets we examine, accounting distortions contribute to the negative relation between accruals and future earnings performance in 14 equity markets. Further, we show that the negative relation between accruals and stock returns could be at least attributable to accounting distortions. In particular, accruals related to accounting distortions predict returns in 7 out of the 9 markets where the accrual anomaly occurs in Europe. Finally, we show that the impact of accounting distortions on the pricing of the accrual component of earnings is stronger in markets with a higher level of trust and a lower level of secrecy.

Traditional Ratios vs. Cash Flow based Ratios: Which One is Better Performance Indicator?

Cash flow prediction is involved in a number of economic decisions, particularly in investment. Previous researches conducted in the United States have provided inconsistency in the results of investigating accounting data, cash flow and accrual accounting data in predicting future cash flows. No published research has studied cash flow prediction in Bangladesh. The current study investigates the ability of accrual and cash flows accounting information to predict future cash flows of Bangladeshi listed companies. This study analyses Balance sheet, Income Statement and Cash Flow statement. In addition, cash flow ratios and Income statement based ratios are calculated in order to get the same pattern of result and to make comparisons. Data used in this study are collected from the financial statements of non-manufacturing companies listed on the Stock Exchange of Bangladesh from 2001 to 2010. Cash flow data are selected directly from the cash flow statements. Empirical results show that cash flow and accrual component of earnings can be used to predict future cash flows of Bangladeshi listed companies and cash flows have better predictive power than traditional based ratios. However, the results indicate that cash flow ratios are sometimes providing the better and accurate picture of the companies. In addition, this study finds that our economic crises as well as abnormal condition of our stock market are caused due to the manipulation of accounting data for consecutive financial year.