The Differential Persistence of Accruals and Cash Flows for Future Operating Income Versus Future Profitability

Posted: 24 Apr 2003

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

Emory University Goizueta Business School

Abstract

Prior research provides evidence that a higher proportion of accrued relative to cash earnings is associated with lower earnings performance in the subsequent fiscal year. The result has been widely interpreted as indicative of higher levels of operating accruals relative to cash flows foreshadowing a subsequent earnings reversal, and thus signaling earnings management. We note, however, that earnings performance in prior studies is typically defined as one-year-ahead operating income divided by one-year-ahead invested capital, or a measure of profitability.

We find that accruals are more highly associated than cash flows with invested capital in the denominator of the profitability measure. In contrast, accruals and cash flows have no differential relation to one-year-ahead operating income. The evidence is not consistent with accruals having a reversal effect on earnings. This suggests that the lower persistence of accruals versus cash flows may not be due to earnings management but may rather be due to the effect of growth on future profitability.

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

JEL Classification: M41, M43, C30, G12, Ll5

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 Profitability. Available at SSRN: https://ssrn.com/abstract=389181

Patricia M. Fairfield

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 (Contact Author)

University of Kansas ( email )

Capitol Federal Hall, #4101
1654 Naismith Dr.
Lawrence, KS 66045
United States
785-864-7577 (Phone)

HOME PAGE: http://https://business.ku.edu/scott-whisenant

Teri Lombardi Yohn

Emory University Goizueta Business School ( email )

201 Dowman Drive
Atlanta, GA 30322
United States

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