Accounting Accruals and Tests of Earnings Management

Abstract

The success of the Jones model has inspired a long line of research on learnings management that utilizes it. In this paper, I augment the Jones and performance-adjusted Jones models by incorporating three measures from financial statements: abnormal beginning non-cash working capital, working capital intensity, and historical depreciation rates. In a number of scenarios including loss avoidance and seasoned equity offerings, I show that unexpected accruals based on the proposed model evince less bias and higher power in testing earnings management compared to those based on the existing models. The proposed accruals model displays the advantages of both the cross-sectional and the time-series Jones models, but overcomes their shortcomings.

Keywords: Earnings Management, Accounting Accruals

JEL Classification: M41, M43, G12, C52