The Implications of Accounting Distortions and Growth for Accruals and Profitability

Posted: 14 Dec 2005

See all articles by Scott A. Richardson

Scott A. Richardson

AQR Capital Management, LLC; London Business School

Richard G. Sloan

University of Southern California - Leventhal School of Accounting

Mark T. Soliman

University of Southern California - Marshall School of Business

A. Irem Tuna

London Business School

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Abstract

Following Sloan (1996), numerous studies document that the accrual component of earnings is less persistent than the cash flow component of earnings. Disagreement exists, however, as to the explanation for this result. One stream of literature follows Sloan's lead in arguing that this result is attributable to accounting distortions (Xie, 2001; Dechow and Dichev, 2002; Richardson et al., 2005). A second stream of literature argues that this result is attributable to a more general growth effect and that growth-related factors such as diminishing returns to new investment explain the lower persistence of accruals (e.g., Fairfield, Whisenant and Yohn, 2003a; Cooper, Gulen and Schill, 2005). We provide new evidence indicating that temporary accounting distortions are a significant contributing factor to the lower persistence of the accrual component of earnings. Our evidence indicates that the lower persistence of accruals extends to accruals that are unrelated to sales growth and that extreme accruals are systematically associated with alleged cases of earnings manipulation.

Keywords: accruals, earnings management, conservative accounting, aggressive accounting

JEL Classification: M41, M43

Suggested Citation

Richardson, Scott Anthony and Sloan, Richard G. and Soliman, Mark T. and Tuna, Ayse Irem, The Implications of Accounting Distortions and Growth for Accruals and Profitability. Accounting Review, May 2006. Available at SSRN: https://ssrn.com/abstract=869408

Scott Anthony Richardson

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Richard G. Sloan (Contact Author)

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States

Mark T. Soliman

University of Southern California - Marshall School of Business ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Ayse Irem Tuna

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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