Do the Notes to the Financial Statements Provide Information about the Degree of Subjectivity in Accruals?
56 Pages Posted: 29 Feb 2016 Last revised: 17 Jan 2019
Date Written: January 9, 2019
Accruals incorporate subjective estimates about future cash flows, cash flow deferrals, depreciation and amortization, and fair value estimates. We examine whether the qualitative disclosures in a firm’s Notes to the Financial Statements (hereafter footnotes) provide information about its accruals subjectivity. We measure accruals subjectivity using the frequency of estimate-related words in the footnotes. Motivated by Sloan (1996) and Richardson et al. (2005), we find that the accruals of firms with greater subjectivity exhibit a lower correlation with future earnings and have lower association with their past, current, and future cash flows in the spirit of Dechow and Dichev (2002). We further document that the likelihood of meeting or beating the analyst consensus earnings forecast increases with accruals subjectivity. Lastly, we find no relation between the degree of accruals subjectivity and the accrual anomaly. Overall, our evidence suggests that the footnotes contain significant information about accruals subjectivity.
Keywords: textual analysis; accruals quality; accruals persistence; accrual anomaly
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