TY - JOUR

T1 - The role of accrual estimation errors to determine accrual and earnings quality

AU - Izadi Zadeh Darjezi, Javad

PY - 2016

Y1 - 2016

N2 - PurposeManagers, investors and security analysts all pay special attention to the bottom line of income statements and they miss significant information included in accruals about the quality of earnings. A considerable portion of the earnings-quality literature examines the possibility of using the accruals to shift reported income among fiscal periods. One of the main roles of working-capital accruals is to adjust the recognition of cash flows. This paper aims to focus on earnings quality by examining the working-capital accruals quality using the method of Dechow and Dichev (2002).Design/methodology/approachFollowing the Dechow and Dichev (2002) model, the result of this paper shows that accrual quality is related to the absolute magnitude of accruals negatively. Also, the standard deviation of accruals, cash flows, sales and earnings is positively related to firm size. The result demonstrates and suggests that these observable firm characteristics can be used as instruments for measuring accrual quality. According to this framework, the author expects that the larger the unsigned abnormal accrual measure, the lower the earnings quality. Therefore, firms with low accrual quality have more accruals that are unrelated to cash flow realisations and so have more noise and less persistence in their earnings.FindingsAfter examining earnings and accrual quality, this paper finds that average UK company behaviour was quite similar to the behaviour found earlier in the USA. This paper’s findings show that greater volatility of sales, cash flow, accruals and earnings results in a lower accrual quality. Without a doubt, some of the analysis in this paper, especially that using different equations to calculate working-capital accruals, leads us to a valuable improvement of the earlier studies.Originality/valueIn this paper, the author follows the method of Dechow and Dichev (2002) and define accrual quality as the extent to which accruals map into cash-flow insights based on the UK data. To find the quality of working-capital accruals, the author uses the standard deviation of the residuals as accrual quality that resulted from the author’s firm-specific OLS regressions of working-capital accruals based on last, current and one-year-ahead operating cash flow. Unlike prior research, to avoid a restriction to working-capital accruals, we use different equations to cover more items of working-capital accruals.

AB - PurposeManagers, investors and security analysts all pay special attention to the bottom line of income statements and they miss significant information included in accruals about the quality of earnings. A considerable portion of the earnings-quality literature examines the possibility of using the accruals to shift reported income among fiscal periods. One of the main roles of working-capital accruals is to adjust the recognition of cash flows. This paper aims to focus on earnings quality by examining the working-capital accruals quality using the method of Dechow and Dichev (2002).Design/methodology/approachFollowing the Dechow and Dichev (2002) model, the result of this paper shows that accrual quality is related to the absolute magnitude of accruals negatively. Also, the standard deviation of accruals, cash flows, sales and earnings is positively related to firm size. The result demonstrates and suggests that these observable firm characteristics can be used as instruments for measuring accrual quality. According to this framework, the author expects that the larger the unsigned abnormal accrual measure, the lower the earnings quality. Therefore, firms with low accrual quality have more accruals that are unrelated to cash flow realisations and so have more noise and less persistence in their earnings.FindingsAfter examining earnings and accrual quality, this paper finds that average UK company behaviour was quite similar to the behaviour found earlier in the USA. This paper’s findings show that greater volatility of sales, cash flow, accruals and earnings results in a lower accrual quality. Without a doubt, some of the analysis in this paper, especially that using different equations to calculate working-capital accruals, leads us to a valuable improvement of the earlier studies.Originality/valueIn this paper, the author follows the method of Dechow and Dichev (2002) and define accrual quality as the extent to which accruals map into cash-flow insights based on the UK data. To find the quality of working-capital accruals, the author uses the standard deviation of the residuals as accrual quality that resulted from the author’s firm-specific OLS regressions of working-capital accruals based on last, current and one-year-ahead operating cash flow. Unlike prior research, to avoid a restriction to working-capital accruals, we use different equations to cover more items of working-capital accruals.

KW - Earnings quality

KW - Estimation errors

KW - Working capital accruals

U2 - 10.1108/IJAIM-04-2015-0022

DO - 10.1108/IJAIM-04-2015-0022

M3 - Journal article

VL - 24

SP - 98

EP - 115

JO - International Journal of Accounting and Information Management

JF - International Journal of Accounting and Information Management

IS - 2

ER -