The Differential Persistence of Accruals and Cash Flows for Future Operating Income Versus Future Return on Assets

26 Pages Posted: 5 Sep 2002 Last revised: 3 Jun 2016

See all articles by Patricia M. Fairfield

Patricia M. Fairfield

Georgetown University - Department of Accounting and Business Law

Scott Whisenant

University of Kansas

Teri Lombardi Yohn

Indiana University - Kelley School of Business - Department of Accounting

Date Written: June 1, 2002

Abstract

Prior research shows that a higher proportion of accrued relative to cash earnings is associated with lower earnings performance in the subsequent period (Sloan 1996). The result has been widely interpreted as indicative of higher levels of operating accruals relative to cash flows from operations signaling (opportunistic) earnings management. We note, however, that earnings performance in prior studies (e.g., Sloan 1996) is typically defined as one-year-ahead operating income divided by one-year-ahead average total assets. Consequently, and not unimportant to our study or prior studies, the deflation of operating income transforms operating income into return on assets (i.e., an income measure into a profitability measure).

We find that accruals have a greater impact than cash flows on one-year-ahead average total assets, the denominator of return on assets. We also find that, although accruals are less persistent than operating cash flows for one-year-ahead return on assets, accruals and cash flows have equivalent associations with one-year-ahead operating income. We conclude that the lower persistence of accruals relative to cash flows should not be interpreted as evidence of earnings management, but instead, as evidence that accruals are more highly correlated with one-year-ahead average total assets than are cash flows.

Keywords: accrued earnings, growth, return on assets, earnings management, financial statement analysis

JEL Classification: M41, M43, G12

Suggested Citation

Fairfield, Patricia M. and Whisenant, Scott and Yohn, Teri Lombardi, The Differential Persistence of Accruals and Cash Flows for Future Operating Income Versus Future Return on Assets (June 1, 2002). Review of Accounting Studies, Vol. 8, No. 2/3, 2003. Available at SSRN: https://ssrn.com/abstract=320060 or http://dx.doi.org/10.2139/ssrn.320060

Patricia M. Fairfield (Contact Author)

Georgetown University - Department of Accounting and Business Law ( email )

McDonough School of Business
Washington, DC 20057
United States
202-687-4583 (Phone)
202-687-4031 (Fax)

Scott Whisenant

University of Kansas ( email )

Capitol Federal Hall
1654 Naismith Dr.
Lawrence, KS 66045
United States
785-864-7577 (Phone)

Teri Lombardi Yohn

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
(812) 855-0430 (Phone)

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