Accruals, Deferrals, Cash Flows and Earnings: Articulation Implications for Earnings Management Models and a Suggested Alternative

Abstract

This paper discusses the implications of using a change in working capital approach to measure accruals and the importance of the distinction between accruals and deferrals in the context of evaluating extant earnings management models. From this discussion, I develop a cash flow mapping model that builds on the Dechow and Dichev (2002) model. A key feature of the proposed model is that it incorporates accrual balances, rather than changes, as they represent more complete measures of the estimates made by managers during a particular period that directly impact that period’s earnings and have yet to settle up. Model validation tests indicate that the proposed model is roughly two to four times as powerful as extant accrual models in detecting earnings manipulation. Additional tests suggest that the model is also not susceptible to performance-related bias — i.e., a major concern of extant accrual models. The discussion and model development in this paper are meant to provide a potential next step for future research in the accrual manipulation literature.

Keywords: accruals, deferrals, cash flows, earnings management, cash flow mapping

JEL Classification: M41