Non-current Accruals Research Articles

The relative valuation of cash flow and current accruals affected by their extremity

PurposeRecent studies on the securities market’s differential pricing of earnings components have shown that cash flow from operations is more highly valued than total accruals and that moderate cash flow from operations has higher valuation than extreme total accruals. An interesting question that follows is whether these findings hold regarding the differential valuations of cash flow and current accruals. This study aims to extend prior research by addressing this issue in two ways. First, the authors examine the incremental information content of cash flow from operations beyond working capital from operations. Second, the authors assess the effect of extreme working capital from operations on the incremental information content of cash flow from operations. This study aims to extend prior research by addressing this issue in two ways.Design/methodology/approachThis study adopts market-based accounting research to test its hypotheses and to achieve its objectives. Specifically, this study uses statistical associations between accounting data and stock returns to examine the incremental information content (value relevance) of cash flow and working capital from operations and the effect of extreme working capital from operations on the incremental information content of cash flow.FindingsThe results show that cash flow from operations is not more highly valued than current accruals (both being valued equivalently). However, moderate cash flow from operations has higher valuation than extreme current accruals (each is valued differently). Overall, these research findings indicate that cash flow becomes more important for valuation as accruals get “extreme”.Practical implicationsAs accruals are unlikely to persist to be permanent across the years, these results can be interpreted as indicating that cash flow and accruals information are used jointly by investors, with one being more important than the other depending on the relative “extremeness” of each. Therefore, both are of value to the investor and both should be reported.Originality/valueThe paper contributes to the UK research on determining the preferred level of disaggregation of earnings components, i.e. operating cash flow, current accruals and non-current accruals. This would help investors to improve their investment and credit decisions.

The Moderating Effect of OPEC and Non-OPEC on the Relationship Between Oil Price Volatility and Accrual Earnings Management in the Oil and Gas Industry

This study is an empirical examination on the relationship between oil price volatility and earnings management in the oil and gas industry, moderated by price-setting abilities of OPEC (Organization of Petroleum Exporting Nations) and price taking abilities of Non-OPEC countries. This study tests discretionary, income-decreasing, current and non-current accruals as a proxy of earnings management. A total sample of 209 firm-year observations from 2008 to 2018 of listed oil and gas firm is collected from the Thomson Datastream database. To incorporate the moderation effect, the samples were divided into two sub-groups, OPEC and Non-OPEC using reserve to production ratio. Firm attributes are included in the analysis as the constant variable such as leverage, current ratio, EBITDA and Growth. The initial results show that, overall, the interaction effect between OPEC/Non-OPEC and oil price volatility is positive and significant to discretionary and income-decreasing accruals. Data samples are limited while comparing OPEC and Non-OPEC countries as not every oil and gas company in OPEC are listed companies and their information is heavily protected. This study contributes to extant earnings management literature regarding political cost, which remains a significant concern to oil and gas companies worldwide.

Articulation-Based Accruals and Audit Fees

This paper examines the relation between audit fees and accruals from a balance sheet auditing perspective. We argue that the underlying economic characteristics of various transactions, as reflected in the articulation-based accruals in Casey et al. (2017), are predictably associated with audit fees. We are the first to demonstrate that total accruals have a non-linear relation with audit prices, with both large positive and large negative total accruals driving audit fees higher. We further disaggregate total accruals based on their accounting and economic characteristics. Accruals originating from the balance sheet and the cash flow statement have a positive relation with audit fees, while the statement of owner’s equity accruals are negatively related to audit fees. We then decompose total accruals into five articulation-based accruals and find that working capital accruals, discontinued operations accruals, and net financial accruals have a linear relationship with audit fees. In contrast, equity investment accruals and net noncurrent operating accruals (mainly driven by depreciation expenses) have a non-linear relationship with audit fees.

Measuring the Persistency of Earnings Components: Applications of the VAR Model to Long-Run Japanese Data

This study investigates the time-series properties of accounting earnings and their components. We propose a new measure of earnings persistency in accordance with the vector autoregressive (VAR) model–linked earnings and stock returns. As a preliminary analysis, we estimate the first-order autocorrelations and test the stationarity of five variables: earnings, cash flows from operations, total accruals, current accruals, and noncurrent accruals. We then confirm that earnings and noncurrent accruals have a more persistent time-series than cash flows and current accruals. Next, we formulate and estimate the first-order autoregressive model composed of the three variables of utmost interest to accounting researchers, namely, cash flows, current accruals, and noncurrent accruals, and explore how future predictions of these three earnings components are affected by unit impulse shocks. Given the results of the impulse response function analysis, we forecast changes in stock prices based on future innovations of these components, finding that a 1% unit shock in the earnings components affects stock prices by 2% to 2.5%. Finally, we are able to demonstrate excess returns by using the portfolio formation method based on our measure of persistence.

Asset Conversion Cycle and Accruals Persistence

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.

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.

The earnings management opportunity for US oil and gas firms during the 2011 Arab Spring event

Purpose – This study aims to examine whether US oil and gas companies engaged in earnings management during the 2011 Arab Spring, which resulted in significant increases in both crude oil and gasoline prices. Design/methodology/approach – Following a similar research methodology from prior research, this study tests the existence of earnings management based on discretionary total accruals, current accruals and non-current accruals to determine whether both large petroleum refining firms and relatively small oil and gas-producing firms, jointly and separately, lowered reported earnings. Findings – The results show that, overall, US oil and gas companies as a group engaged in income-decreasing earnings management during the Arab Spring. The results seem to support the political cost hypothesis. However, further analyses indicate that the results are driven by abnormal income-decreasing accruals of the relatively small oil and gas-producing firms, which are politically less sensitive. Research limitations/implications – The findings suggest that there may be other non-political cost incentives, such as income smoothing, for the relatively small oil and gas-producing firms managing earnings downward during periods of large oil price increases. However, the possibility for firms with reversals of income-increasing activity from other quarters is not ruled out. Originality/value – This study not only is the first empirical study of earnings management by oil and gas companies during the Arab Spring, but also contributes to extant earnings management literature regarding political cost hypothesis, which still remains a major concern for US oil and gas companies.

Relevance of Goodwill Impairments to Cash Flow Prediction and Forecasting

This study examines the contribution of goodwill impairment information to the prediction and forecasting of future operating cash flows. Extending the framework of Barth, Cram, and Nelson, we find that explicitly including goodwill impairments incrementally improves 1-year-ahead cash flow prediction and forecasting. Improved cash flow forecasting is present over the entire 2001-2009 study period as well as for each year within the study window. In addition, goodwill impairments retain their significance and predictive power when other non-recurring charges (e.g., restructuring, asset write-downs, and merger and acquisition costs) are added to the model, both individually and aggregately, and when market-related information (i.e., change in market capitalization) is included in the model. While these findings are validated by in-sample prediction techniques, this study is also one of only a few studies to investigate the incremental, out-of-sample predictive power of non-current accruals on reported (as opposed to computed) operating cash flows. Analysts, investors, creditors, and others interested in future cash flows should separately consider goodwill impairment information, when available, to improve the accuracy of cash flow prediction and forecasting.

The Study of Informative Value of the Operating Cash Flow, Current and Noncurrent Accruals and Stock Market Value in the Capital Market of Iran

This paper aims to study the theoretical fundamentals of informative value of the operating cash flow, current and noncurrent accruals in the capital market of Iran based on descriptive and applied research. Statistical population of the study consisted of 63 companies accepted in Tehran Stock Exchange in a 5-year period from 19/03/2008 till 19/03/2013. In order to study the effect of the research variables, the authors considered the informative value of the operating cash flow, current and noncurrent accruals as independent variables and stock market value as dependent variable. Then, the relations among variables were considered. So, nine hypotheses were made and the relevant data were collected. For studying the relation between the variables, i.e. informative value of the operating cash flow, current and noncurrent accruals and stock market value, the multiple linear regressions method was applied. According to the analyses carried out on the variables, and their indicators, we found out that the informative value of operating cash flow has a significant effect on the stock market value, but the informative value of current and noncurrent accruals has no significant effect on the stock market value.

The value relevance of cash flows, current accruals, and non-current accruals in the UK

Cash flow statements have a longstanding history as mandated financial statement disclosures, having replaced funds flow statements. The usefulness of such disclosures with respect to one of the main purposes of financial statements—providing information relevant to the assessment of future cash flows and their uncertainty, and the market value of firms—is still subject to debate. This study investigates whether various partitions of earnings involving combinations of a cash flow measure of performance and measures of current accruals and non-current accruals improve the ability to explain market values in the UK relative to using earnings alone. Using a valuation model-based methodology, and employing a UK sample of non-financial firms for the years 1993 to 2007, our results suggest strong support for the assertion that cash flows can have incremental value relevance relative to either earnings or funds flows. By implication, cash flows can have separate value relevance from total and, in particular, current accruals. There is slightly less consistent evidence that current and non-current accruals can have separate value relevance but, nonetheless, the results are still strongly in favour in this respect. Generally, the main source of increase in explanatory power for market values is the separate inclusion of our cash flow measure in the estimated regressions. As a consequence, we conclude that the statement of cash flows in the UK provides information useful to UK investors in valuing firms. Further, requiring a cash flow statement, as opposed to a funds flow statement, improves the information content of financial statements in the UK.

The Value Relevance of Cash Flows, Current Accruals, and Non-Current Accruals in the UK

Cash flow statements have a longstanding history as mandated financial statement disclosures, having replaced funds flow statements. The usefulness of such disclosures with respect to one of the main purposes of financial statements - providing information relevant to the assessment of future cash flows and their uncertainty, and the market value of firms - is still subject to debate. This study investigates whether various partitions of earnings involving combinations of a cash flow measure of performance and measures of current accruals and non-current accruals improve the ability to explain market values in the UK relative to using earnings alone. Using a valuation model-based methodology, and employing a UK sample of non-financial firms for the years 1993 to 2007, our results suggest strong support for the assertion that cash flows can have incremental value relevance relative to either earnings or funds flows. By implication, cash flows can have separate value relevance from total and, in particular, current accruals. There is slightly less consistent evidence that current and non-current accruals can have separate value relevance but, nonetheless, the results are still strongly in favour in this respect. Generally, the main source of increase in explanatory power for market values is the separate inclusion of our cash flow measure in the estimated regressions. As a consequence, we conclude that the statement of cash flows in the UK provides information useful to UK investors in valuing firms. Further, requiring a cash flow statement, as opposed to a funds flow statement, improves the information content of financial statements in the UK.

Revisiting the Usefulness of Current Versus Non-Current Accruals

Revisiting the Usefulness of Current Versus Non-Current Accruals

Managerial Discretion and Bias in Annual Forecast Errors

Abarbanell and Lehavy (2003a) empirically link abnormal accruals to two asymmetries in the forecast error distribution (i.e., a high incidence of extreme negative forecast errors and a high incidence of small positive errors) and identify two alternative explanations: (1) that analyst bias is differentially exacerbated by abnormal accruals, or (2) managerial discretion introduces a bias in reported earnings that analysts are unable or unwilling to incorporate in their forecasts. For the lower tail asymmetry, we test these competing hypotheses using forward and reverse regressions that relate contemporaneous forecasts and reported earnings conditional on various earnings components (i.e., cash flow, normal and abnormal accruals). We fail to find that analyst forecast bias is exacerbated by large abnormal accruals. However, our evidence is consistent with analysts being unable or unwilling to forecast managerial discretion in reported earnings, particularly non-current abnormal accruals, which contributes to the frequency of large negative forecast errors. Alternatively, applying the methodology in Abarbanell and Lehavy (2003a) to the middle asymmetry issue, we show that abnormal accruals do not uniquely contribute to firms just beating analysts' forecasts. Further, using an alternative methodology, we fail to find that abnormal accruals contribute to the middle asymmetry. Rather, we find evidence that both income-increasing real earnings management activities and analyst inefficiencies are likely contributors to the middle asymmetry phenomenon.

Information in Accruals About the Quality of Earnings

We extend the analysis in Sloan (1996) to identify the source of information in accruals about earnings quality. Our results indicate that information in accruals about earnings quality is not limited to the current accruals analyzed by Sloan, but extends to non-current accruals. We also show that while information in accruals originates almost exclusively from asset accruals, liability accruals play a useful role in helping to isolate information in asset accruals about earnings quality. Finally, we show that information in accruals about earnings quality originates from both growth in the scale of operations and deterioration in the efficiency of asset usage. Overall, our results indicate that total accruals, defined as the difference between earnings and free cash flows, provide an intuitive, robust and parsimonious measure of earnings quality. Contrary to existing studies, our results also indicate that the information in accruals about earnings quality is not attributable to a single factor, such as 'discretionary' accruals or firm growth.

Controlling for Lagged Stock Price Responses in Pricing Regressions: An Application to the Pricing of Cash Flows and Accruals

This study reevaluates the securities market's differential pricing of the operating cash flow, current accrual (noncash working capital), and noncurrent accrual components of earnings. This reevaluation is motivated by evidence in Sloan [1996] of a lagged adjustment of securities prices to the differing implications of operating cash flows and accruals for future earnings. Similar to previous research, we find no statistically significant differential valuations of operating cash flows and current accruals in the conventional model that relates contemporary security returns to changes in these earnings components. When we allow for the market's multiyear correction of past mispricing and mean reversion in the earnings components, we document significant valuation differences for operating cash flows, relative to both current and noncurrent accruals. Section 2 provides background and motivation for our hypotheses. The research design and empirical results are presented in section 3, followed by a summary and conclusion in section 4.

The Incremental Information Content of Accruals: Evidence Based on the Exponential Smoothing of Levels and Trends in Pre‐Tax Earnings, Funds Flow and Cash Flow

By arranging the accrual accounting identity as a hierarchy of market response models, this paper investigates whether current and noncurrent accruals have incremental information content beyond earnings. The results indicate that the increase in explanatory power attributable to funds flow and cash flow disclosure can be improved upon by estimating the surprises in reported numbers by exponentially weighting prior values. The unexpected information simplifies to the weighted sum of deviations from the estimated level and estimated trend. Further improvements are obtained by allowing components of the error to vary with time and by company in a non‐autoregressive, homoscedastic pooling scheme which takes account of the joint presence of time series disturbance and cross sectional disturbance.

The Information Content of Earnings, Revenues, and Expenses

In this paper we model risk-adjusted returns at earnings announcements as a function of unexpected revenues and unexpected expenses, in order to test for the information content of the components of earnings as well as for their incremental information content over earnings. We use Value Line (VL) forecasts of earnings and revenues as a proxy for the market's expectation of these numbers and as a basis for the market's expectation of expenses. We find both revenues and expenses have information content that is incremental to earnings. We also model riskadjusted returns as a function of earnings and revenues to compare our findings with previous research that used a martingale model to derive expected revenues. Consistent with previous research, we find no incremental information content in revenues in this formulation. However, we find information content in both earnings and revenues when expectations are taken from VL forecasts. Wilson [1986] found that investors used the earnings and revenues released at the preliminary announcement date to forecast the accruals and funds subsequently disclosed in the annual report or 10-K. However, he found no evidence of information content for revenues at this date. Wilson used prior periods' revenues, cash from operations, current and noncurrent accruals, and capital expenditures to predict revenues. Using