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The Role of Accruals in Conveying Managers’ Private Information about Future Cash Flows and an Accounting-based Measure of Conservatism
Senyo Tse, Texas A & M University
Anup Srivastava, Texas A & M University
ABSTRACT. Prior studies find that accounting accruals are associated with future cash flows, suggesting that managers use accruals to communicate their cash flow expectations to investors. We examine the association between future cash flows and large negative, moderate, and large positive accruals using a three-regime error correction model. We hypothesize that consistent with conservatism, managers record smaller profits in anticipation of a given amount of positive cash flow than the losses they recognize in anticipation of the same amount of negative cash flow. We find results consistent with our hypothesis. Our study extends prior research by showing that the relation between the accruals and future cash flows depends on the magnitude and sign of accruals. More importantly, we provide an accounting-based approach to measuring differences in the extent of conservatism across groups of firms.
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