The Implications of accounting distortions, growth and losses for accruals and profitability: Australian evidence

Recent research examines the implications of components of accruals for future profitability. Richardson, Sloan, Soliman and Tuna (2006) decompose accruals into components in order to explain the lower persistence of accruals for future profitability, relative to the cash flow component of earnings. Prior research suggests that the persistence of earnings varies with profitability. If earnings persistence varies between profitable and loss-making companies, then we would also expect differences in the persistence of the components of earnings. We find evidence suggesting that the component of accruals related to revenue growth and change in asset turnover are less persistent than the cash flow component of earnings for profitable Australian companies. For loss-making companies, however, the persistence of the accrual component of earnings is found to be higher than for the cash flow component of earnings, suggesting that the accrual component is more informative than the cash flow component in explaining period ahead profitability for many currently unprofitable companies. The relatively higher persistence of total accruals extends to accruals that are related to revenue growth and accruals that are unrelated to growth that have been inferred to capture elements of accounting distortions.