Accounting Estimates: Pervasive, Yet of Questionable Usefulness

52 Pages Posted: 8 Oct 2008

See all articles by Baruch Lev

Baruch Lev

New York University - Stern School of Business

Siyi Li

University of Illinois at Chicago

Theodore Sougiannis

University of Illinois at Urbana-Champaign - Department of Accountancy

Multiple version iconThere are 2 versions of this paper

Date Written: April 2005

Abstract

Estimates and projections are embedded in most financial statement items. These estimates potentially improve the relevance of financial information by providing managers the means to convey to investors forward-looking, inside information (e.g., on future collections from customers via the bad debt provision, or on expected assets' cash flows reflected in impairment charges). On the other hand, the quality of financial information is compromised by: (i) the increasing difficulty of making reliable forecasts in a fast-changing, often turbulent economy, and (ii) the frequent managerial misuse of estimates to manipulate financial data. Given the prevalence of estimates in accounting data, whether these opposing forces result in an improvement in the quality of financial information or not is arguably the most fundamental issue in accounting.We examine in this study the contribution of accounting estimates embedded in accruals to the quality of financial information by focusing on the major use of this information by investors - the prediction of enterprise cash flows and earnings. Our extensive tests, reflecting both the statistical and economic significance of estimates, indicate that, by and large, accounting accruals and the estimates they embed do not improve the quality of financial information in terms of enhancing the prediction of enterprise performance. Accruals do not improve the prediction of cash flows, beyond that achieved by current cash flows, and improve only marginally the prediction of earnings. This latter improvement, however, appears to be economically insignificant. Thus, the objective difficulties of generating reliable estimates and projections in a volatile economy, and their frequent misuse by managers appear to offset the positive role of estimates in conveying forward looking information to investors.

Suggested Citation

Lev, Baruch Itamar and Li, Siyi and Sougiannis, Theodore, Accounting Estimates: Pervasive, Yet of Questionable Usefulness (April 2005). NYU Working Paper No. BARUCH LEV-09. Available at SSRN: https://ssrn.com/abstract=1280690

Baruch Itamar Lev (Contact Author)

New York University - Stern School of Business ( email )

40 West 4th Street, Suite 400
New York, NY 10012
United States
212-998-0028 (Phone)
212-995-4001 (Fax)

HOME PAGE: http://www.baruch-lev.com

Siyi Li

University of Illinois at Chicago ( email )

601 South Morgan Street
University Hall, Room 2303
Chicago, IL 60607
United States
312-996-0727 (Phone)

Theodore Sougiannis

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

360 Wohlers Hall
1206 South Sixth Street
Champaign, IL 61820
United States
217-244-0555 (Phone)
217-244-0902 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
380
rank
7,525
Abstract Views
2,555
PlumX Metrics
!

Under construction: SSRN citations will be offline until July when we will launch a brand new and improved citations service, check here for more details.

For more information