A Re-Examination of the Costs (and Benefits) to Equity Investors from Including Accruals in Financial Reporting

Abstract:     
Based on assertions that unreliable accruals can be "extremely costly" to investors (Richardson et al. 2005), we re-examine how the accrual component of earnings is associated with current-period and future-period returns to better understand if accruals can be beneficial in investment decisions. We find that accruals exhibit significantly positive associations with current-period returns, insignificant negative associations with future-period returns, and significantly positive associations with two-year returns cumulated over current and future periods. The results using current-period and two-year returns indicate that accruals contain beneficial information about corporate performance. The insignificant associations with future returns contradict prior conclusions that accruals impose future trading losses on investors. When the results from all three returns periods are considered together, the evidence fails to support prior conclusions that the costs and benefits to investors are explained by accrual reliability.

Keywords: Accruals, Cash Flows, Accrual Anomaly, Accounting Standard Setting

JEL Classifications: M41

Working Paper Series