Simulation Evidence on the Properties of Alternative Measures of Working Capital Accruals

What is it about?

Accounting information quality is fundamental to various stakeholders including investors and standard-setters. Given the multi-dimensionality of accounting information, the existing literature has pre-dominantly relied on an approach based on the modified DD model – a model first proposed by Dechow and Dichev (2002) and modified by Bushman et al (2011), to examine accounting information quality. This paper assesses the specification and explanatory powers of the DD and modified DD models by empirically examining data on UK listed firms over the period 2000-2013. Using panel regression methods, we examine accruals quality based on firm-specific regressions of working capital accruals on one-period lagged, current, and one-period lead cash flows from operations. We find that adding additional explanatory variables on firm characteristics add additional explanatory power to the DD model to the extent to which accruals map into cash flow insights based on the UK data.

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Why is it important?

This study empirically well fits with the internal workings of cash flows.

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