We show that accruals consist of at least two distinct underlying processes, one with positive serial correlation and the other with negative serial correlation. We also find that the accrual reversals characterizing the negatively serially correlated process are predominantly good accruals that correctly anticipate fluctuations in working capital. Accrual estimation error is the least persistent component of earnings, while accruals relating to firm growth are less persistent than cash flows. Finally, the mispricing of accruals appears to be driven by a combination of accrual estimation error and firm growth.

ABSTRACT We examine how fair value accounting affects debt contract design, specifically the use and definition of financial covenants in private loan contracts. Using SFAS 159 adoption as our setting, we find that a small but significant proportion of loans (14.5%) modify covenant definitions to exclude the effects of SFAS 159 fair values. Only a limited number of these modifications exclude assets elected at fair value (less than 7%), while all exclude liabilities elected at fair value. Notably, we document that covenant definition modification is unassociated with ex ante fair value elections. We find that covenant definition modification positively varies with common incentive problems attributed to fair value accounting and negatively varies with benefits attributed to fair value accounting. Our results suggest that fair value accounting is not uniformly detrimental for debt contracting and fair value adjustments are included when they are most likely to improve performance measurement.

ABSTRACT We investigate the impact of the mixed attribute GAAP measurement model on accrual quality inferences. GAAP rules vary from an income statement “matching” focus to a balance sheet “fair-value” focus. Accrual properties are also affected by the business activity being measured and the activity's recurrence. Furthermore, accrual measurement is affected by managerial estimation error/manipulation. As a consequence, accruals are heterogeneous with predictably different statistical properties. We construct a dataset of more than 100,000 accrual items that Compustat aggregates into data item FOPO. We classify these accruals into 32 types over a 21-year span. We show that variation in persistence for the 32 accrual types is consistent with our predictions concerning GAAP rules. We provide a model of accruals and show that it is implausible for estimation error of reasonable magnitudes to explain this variation. Finally, we develop a measure of reporting consistency and show its impact on accrual quality inferences.

This study investigates whether market participants perceive pro forma earnings to be more informative and more persistent than GAAP operating income by analyzing a sample of 1,149 actual pro forma press releases. We find that pro forma announcers report frequent GAAP losses and are mostly concentrated in the service and high-tech industries. Our analyses of short-window abnormal returns and revisions in analysts’ one-quarter-ahead earnings forecasts indicate that pro forma earnings are more informative and more permanent than GAAP operating earnings. Our evidence suggests that market participants believe pro forma earnings are more representative of “core earnings” than GAAP operating income.