We provide evidence that accruals quality in the U.S. has generally improved since 2000, following a decade of decline during the 1990s. Our results indicate that both the initial decline in accruals quality and the subsequent reversal can be explained by an inverse relation with operating cash flow volatility. Moreover, even though patterns of cash flow volatility and accruals quality vary in different regions of the world and relative to the U.S., we find evidence of an inverse relation between accruals quality and cash flow volatility globally. We corroborate our main results in a battery of additional tests, which also indicate that our results are not attributable to other explanations. Overall, our evidence challenges conventional wisdom and suggests that concerns about a sustained decline in accruals quality over time are unwarranted.

Cash flow hedge derivatives are an example of an economic transaction that is not fully portrayed in the financial statements in two key ways. First, while changes in the fair value of the derivative are recorded at each reporting date, changes in the value of the underlying purchase or sale commitment are not recorded or disclosed until that transaction occurs. Therefore, until the purchase or sale occurs, the financial statements only portray half of the economic transaction. Second, the gains/losses associated with these derivatives provide an inverse signal about the persistence of firm profitability. We document a method by which financial statement users can partially adjust for these distortions and find evidence that debt investors incorporate information conveyed by cash flow hedge gains/losses into their pricing of new debt issuances. We also find evidence that credit analysts incorporate these adjustments into their firm‐level credit ratings but are unable to find consistent evidence of similar adjustments to credit ratings on new debt issuances. Overall, our results suggest that a subset of sophisticated investors (i.e., those in public debt markets) appear to incorporate information from cash flow hedge accounting into their assessments of firm risk, and that users may benefit from enhanced disclosure about the amount and timing of a firm's future transactions that are exposed to foreign currency, interest rate, or commodity price risk as well as the amount and timing of derivatives that protect the firm from those risks.