Why Do Accruals Predict Earnings?

Posted: 11 Jan 2019

See all articles by Jonathan Lewellen

Jonathan Lewellen

Dartmouth College - Tuck School of Business; National Bureau of Economic Research (NBER)

Robert J. Resutek

University of Georgia - J.M. Tull School of Accounting

Date Written: November 27, 2018

Abstract

Higher accruals are associated with lower subsequent earnings. We show this phenomenon can be explained by the way sales, profits, and working capital respond to changes in a firm's product markets. Empirically, high accruals predict high subsequent sales growth but a long-lasting drop in both profits and profitability. Accruals also predict an increase in future competition, suggesting that accruals are correlated with abnormally high — and, in equilibrium, transitory — true profitability that attracts new entrants to the industry. Overall, the predictive power of accruals is better explained by product-market effects than by measurement error in accruals or diminishing returns from investment.

Keywords: Accruals, Earnings Persistence, Measurement Error, Reversals

JEL Classification: G14, M41

Suggested Citation

Lewellen, Jonathan W. and Resutek, Robert J., Why Do Accruals Predict Earnings? (November 27, 2018). Journal of Accounting & Economics (JAE), Vol. 67, No. 1, 2019, Available at SSRN: https://ssrn.com/abstract=3309199

Jonathan W. Lewellen

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States
603-646-8650 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Robert J. Resutek (Contact Author)

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States

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