Identifying Accounting Quality

62 Pages Posted: 23 Aug 2014 Last revised: 15 May 2018

Valeri V. Nikolaev

University of Chicago Booth School of Business

Date Written: April 25, 2018

Abstract

In this paper, I develop a new approach to modeling and understanding accounting accruals. I introduce a model that explicitly incorporates the role of accruals in measuring firm performance. Using this model, I characterize accounting quality by the degree to which accruals fulfill their performance measurement objective. To identify accounting quality, the model exploits the institutional properties of accounting information that both earnings and cash flows represent noisy measures of the unobservable economic performance, and that they converge as the measurement horizon extends. These properties allow decomposing the variance of accruals into both the performance measurement component and the accounting error component, as well as identifying the variance of the unobservable economic performance itself. I implement several model specifications and consider a number of generalizations. My analysis suggests that, on average, the portion of accruals that facilitates performance measurement significantly exceeds the level of accounting error in accruals. I conclude that accruals successfully meet their primary objective.

Keywords: Accounting quality, Earnings quality, Accruals, Identification, Estimation error

JEL Classification: M41

Suggested Citation

Nikolaev , Valeri V., Identifying Accounting Quality (April 25, 2018). Chicago Booth Research Paper No. 14-28. Available at SSRN: https://ssrn.com/abstract=2484958 or http://dx.doi.org/10.2139/ssrn.2484958

Valeri V. Nikolaev (Contact Author)

University of Chicago Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/valeri.nikolaev/index.html

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