Expected Accrual Models: The Impact of Operating Cash Flows and Reversals of Accruals

Abstract

This paper augments the Jones (1991) model with operating cash flows and lagged accruals to evaluate the impact of (1) the negative association between accruals and concurrent cash flows, (2) the positive association between accruals and lagged cash flows, and (3) the reversal of accruals. I find that operating cash flows greatly improve the explanatory and predictive power of the Jones model; but, lagged accruals do not. A market test of the expected and unexpected components of accruals indicates that unexpected accruals are on average informative with respect to concurrent stock returns; however, the market does not fully understand the implications of accruals anticipated at the beginning of the return period.

Keywords: Unexpected accruals, expected accruals, discretionary accruals, nondiscretionary accruals, Jones model, reversals of accruals

JEL Classification: M41, M43, G12