An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Michael Mosebach
Univerisity of Arkansas

Paul Simko
University of Virginia - Darden

Abstract: We examine whether discretionary accruals explain firms’ ability to sustain profitability after a series of losses. We posit that when firms approach profitability, they accumulate reserves in anticipation of reversing those reserves when the firm becomes profitable. We find results consistent with this behavior. We also find consistently positive discretionary accruals following initial profitability. The accrual behavior for firms sustaining profitability contrasts to that of firms unable to sustain. In the quarters preceding the an initial reported profit, firms unable to sustain profitability use higher income increasing discretionary accruals, a pattern that does not continue in future quarters as these firms again revert to a loss state. We also find that past discretion relates inversely to future profitability, but only for those firms able to sustain profits. We interpret our results as evidence toward discretionary accrual planning extending beyond a single period.

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