Triángulo financiero o de poder

An important aspect of the present study is to focus on accruals and earnings characteristics to produce a better understanding of the impact of accruals mispricing. The main reason behind this focus is that earnings and accruals characteristics have different predictive values for forecasting future returns. These essential characteristics may put pressure on accruals mispricing, or they can explain accruals mispricing.

The abnormal accruals can be driven by unreliable accruals components, with reliability being defined as the level of subjectivity associated with each component. The research shows that more reliable accruals components have higher persistence than less reliable components on earnings (Richardson et al, 2005). Sloan (1996) provides evidence that accruals mispricing is the reason that the market is unable to price the different persistence of earnings components correctly when forecasting future earnings, and he shows that more reliable components of accruals would be less mispriced than less reliable components.

Richardson et al. (2005) disaggregate total accruals into their different components and classify them into reliable versus less reliable categories. These authors provide evidence that the less reliable components are the items having a lower persistence in predicting future earnings. Moreover, it seems that the market’s inability to price the lower persistence of the less reliable accruals components correctly, leads to a mispricing of these components. Also, the less reliable accrual component leads to an

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abnormal return and this is higher than the one obtained if using the most reliable accrual component.

According to Richardson et al. (2005) investors are unable to price the effect of special items on future earnings correctly. Subsequently, Dechow and Ge (2006) analyse the effect that special items have on accruals mispricing. Dechow and Ge argues that the behaviour of earnings persistence differs between high and low accruals firms. They provide evidence that firms with low accruals are characterised by a reduction in assets due to downsizing, and assets are reduced by asset impairment and it shows that the accruals information is associated with the structure of the balance sheet. As a result, firms with low accruals will report temporary items if the reported earnings causes their earnings persistence to decrease.

Firms with high accruals, especially firms characterised by large positive accruals are more likely to be growing but, according to accounting conservatism, the future benefits of such events are not accounted for in the balance sheet, while their costs are directly expensed. As a consequence, these firms are more likely to report transitory negative cash flows that are mitigated by accruals and improve earnings persistence. Empirical evidence regarding this issue is documented in prior studies. In regards to accrual anomaly, Xie (2001) shows that the market overestimates the persistence of discretionary accruals and thus overprices them. Other researchers such as DeFond and Park (2001) find that the earnings response coefficient (ERC) is higher or lower when discretionary accruals show the magnitude of a positive earnings surprise. DeFond and Park suggests that the market partially adjusts for the possibility of accruals management on the earnings announcement date. Other researchers Baber et al. (2006) confirm the DeFond and Park results and show that the ability of market participants to detect

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earnings management is improved when firms elect to provide a balance sheet and cash flow disclosures at earnings announcement.

Overall, the evidence shows that accruals reliability is one of the factors affecting accruals mispricing. Thus in the present study, accruals are used instead of operating accruals.

2.2.6 Management of accruals and accrual reversals

Accruals are created when the expenses and revenues that build income are not completely cash based. In other words, accruals show the amounts that are received as revenue and expenses are incurred but do not convert into cash on the balance sheet and do not show up on the income statement. The net income reports both cash income and accrual income. All firms always have a certain level of accruals as presented in Generally Accepted Accounting Principles (GAAP). Therefore, net income is divided into two parts: Cash income and Total accruals as follows:

Net Income = Cash income + Total Accruals (2.1) An increase in accruals can accompany an increase in income. Accruals can turn into cash, so they can give investors valuable information about the future cash flow of firms. However, sometimes accruals do not turn into cash therefore, some managers use accruals to hide their inability to generate cash income for shareholders. There is a question here: research is needed into when the use of accruals is ethical and when it is unethical. Total accruals can be measured by the balance sheet method or cash flow

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method. The balance sheet method11 of measuring accruals is captured by equation (2.2) below.

Total Accruals =Δ (Current assets – Cash) – Δ (Current liabilities) - Depreciation (2.2) The cash flow12 method for measuring is the equation (2.3);

Total accruals = Earnings before extraordinary items and discontinued operations - Operating cash flow + Depreciation and amortization (2.3) Managing current accruals suggests itself as a potentially popular technique for managing earnings. Healy (1985) demonstrates that accrual management is less costly and more likely on a multi-period basis than changes in accounting methods as a means of transferring earnings between periods. Also, DeFond and Jiambalvo (1994) point out that working capital accruals are more susceptible to manipulation than non-working capital accruals13. This study investigates the links between discretionary working capital accruals and stock returns in the short term.

The accrual process is an important aspect of financial accounting. There is limited research documenting and explaining the properties of accruals in interim periods. This study seeks to contribute to research in this area by documenting some fundamental properties of accounting accruals in the short term and describes their implications for accounting research and practice.

11 _{The balance sheet method use changes in various amounts of balance sheet items to measure the accruals}

component through the net income.

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The cash flow method implies operating cash flows to measure the accrual components of net income. 13

Kreutzfeldt and Wallace (1986) show that accounts receivable, inventory, accounts payable, accrued liabilities and also fixed assets are among the five accounts in which errors are most frequently detected by auditors. They also provide evidence that judgmental errors (e.g., underestimation of bad debt expense) are relatively frequent for these accounts. They find such judgmental ‘errors’ are consistent with manipulation.

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Allen et al (2011) provide evidence that extreme accruals lead to a disproportionately high frequency of extreme reversals and reversals can impact earnings in the future. As an example, they demonstrate that extreme positive inventory accruals are followed by a high frequency and magnitude of subsequent inventory write-downs. Also, they show that the popularity of extreme accrual reversals explains a number of results from prior research. They show a negative relationship between accruals and future stock returns which are attributable to accrual reversals frequency. In addition they show that extreme accruals are associated with systematic reversals indicating that accountants and auditors are unsuccessful at identifying the systematic errors in extreme accruals.