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

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  • Patricia M. Fairfield

    (Georgetown University)

  • Scott Whisenant

    (The University of Houston)

  • Teri Lombardi Yohn

    (Georgetown University)

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.

Suggested Citation

  • Patricia M. Fairfield & Scott Whisenant & Teri Lombardi Yohn, 2003. "The Differential Persistence of Accruals and Cash Flows for Future Operating Income versus Future Profitability," Review of Accounting Studies, Springer, vol. 8(2), pages 221-243, June.
    • Handle: RePEc:spr:reaccs:v:8:y:2003:i:2:d:10.1023_a:1024413412176
    DOI: 10.1023/A:1024413412176
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    Cited by:

    1. Adam Esplin & Max Hewitt & Marlene Plumlee & Teri Lombardi Yohn, 2014. "Disaggregating operating and financial activities: implications for forecasts of profitability," Review of Accounting Studies, Springer, vol. 19(1), pages 328-362, March.
    2. Patricia M. Dechow & Scott A. Richardson & Irem Tuna, 2003. "Why Are Earnings Kinky? An Examination of the Earnings Management Explanation," Review of Accounting Studies, Springer, vol. 8(2), pages 355-384, June.
    3. Stephen H. Penman & Nir Yehuda, 2009. "The pricing of earnings and cash flows and an affirmation of accrual accounting," Review of Accounting Studies, Springer, vol. 14(4), pages 453-479, December.
    4. Patricia M. Dechow & Weili Ge, 2006. "The persistence of earnings and cash flows and the role of special items: Implications for the accrual anomaly," Review of Accounting Studies, Springer, vol. 11(2), pages 253-296, September.
    5. Linna Shi & Huai Zhang, 2012. "Can the earnings fixation hypothesis explain the accrual anomaly?," Review of Accounting Studies, Springer, vol. 17(1), pages 1-21, March.

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