Information in Accruals About the Quality of Earnings

Abstract:     
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.

Keywords: Accruals; Growth; Efficiency; Abnormal returns

JEL Classifications: M41, M43, G12

Working Paper Series