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Accrual Reliability, Earnings Persistence and Stock Prices Case Study

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Updated: Jul 18th, 2020

Introduction

Richardson, Sloan, Soliman, and Tuna attempt to investigate a linkage between the level of how significantly accruals are managed and how reliable they are to the earnings persistence. The general hypothesis is that the main difference between persistence observed in cash flow and persistence of accruals lies in the fact that the latter is affected by a greater amount of subjectivity. In other words, the implication is that the managers would be able to make the earnings seem smoother in their reports and to provide judgment about the future earnings and the level of cash flow.

Two of the major concepts in terms of researching accounting documents are the relevance and reliability of the managerial accruals. While the former is in the center of the researchers’ attention, there is a possibility that the latter has a greater number of implications for defining the reasons and mechanisms of earnings management using managing accounting accruals.

Richardson et al. also examine how the categorization of accruals is connected with earnings management and mispricing. It leads to analyzing how the persistence of earnings along with the associated mispricing in certain accruals will indicate the need to define the reliability of those accounting accruals.

Research design

The research is designed to rely on the hypothesis that the subjectivity of managers incorporated in assessing accounting accruals is an intermediate cause of the differences between the properties of those accruals and regular cash flow earnings, which eventually affects the persistence of earnings and stock prices. In other words, “accountants more typically refer to the degree of subjectivity involved in an accounting measurement in terms of the verifiability and reliability of the measurement” (Richardson et al. 445).

Thus, it is important to develop and anticipate various scenarios of managerial situations, which will include different variables, such as earnings persistence, accrual reliability, accrual relevance, a degree to which earnings are managed, stock prices, recognition of sales revenues, the personal benefit of the managers, etc. In such a way, to include all the aspects, evaluating reliability needs to be combined the accrual categories.

Data and results

There are, however, certain limitations to the study discovered in the process of collecting data and analyzing results. First of all, the assumption is that cash flow is reported correctly, which is not always true in the actual situation. Secondly, the categorization of accounting accruals was based on the broad balance sheet. As a result, there were some limitations in terms of the decomposition of the associations between earnings management and particular types of accruals.

The data collected by Richardson et al. included all the firms registered in the Compustat and CRSP daily stock databases (Richardson et al. 451). The combined use of those two sources allowed to include all the variables of designed research and to expand on the implications for stock prices.

Overall, the descriptive statistics showed that there is a correlation not only between the relevance of accruals and inclusion of potential risks in financial reporting but also between the reliability of those accruals and the reported level of operational liability (Richardson et al. 474).

Conclusion and implications

There are several insights provided by the research of Richardson et al. Firstly, accruals with lesser reliability result in decreasing earnings persistence because of mispricing and misreporting liability. Secondly, there is a need to continue developing the categorization of accruals since it helps to look at the broader theme. However, Richardson et al. met some limitations to their research in terms of explaining the divergences of earnings persistence for accruals and cash flow.

Works Cited

Richardson, Scott, Richard Sloan, Mark Soliman, and Irem Tuna. “Accrual Reliability, Earnings Persistence and Stock Prices.” Journal of Accounting and Economics 39.3 (2005): 437-485. Print.

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IvyPanda. (2020, July 18). Accrual Reliability, Earnings Persistence and Stock Prices. Retrieved from https://ivypanda.com/essays/accrual-reliability-earnings-persistence-and-stock-prices/

Work Cited

"Accrual Reliability, Earnings Persistence and Stock Prices." IvyPanda, 18 July 2020, ivypanda.com/essays/accrual-reliability-earnings-persistence-and-stock-prices/.

1. IvyPanda. "Accrual Reliability, Earnings Persistence and Stock Prices." July 18, 2020. https://ivypanda.com/essays/accrual-reliability-earnings-persistence-and-stock-prices/.


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IvyPanda. "Accrual Reliability, Earnings Persistence and Stock Prices." July 18, 2020. https://ivypanda.com/essays/accrual-reliability-earnings-persistence-and-stock-prices/.

References

IvyPanda. 2020. "Accrual Reliability, Earnings Persistence and Stock Prices." July 18, 2020. https://ivypanda.com/essays/accrual-reliability-earnings-persistence-and-stock-prices/.

References

IvyPanda. (2020) 'Accrual Reliability, Earnings Persistence and Stock Prices'. 18 July.

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