DISCRETIONAL ACCOUNTING CHOICES

Discretional Accounting Choices and the Predictive Ability of Accruals With Respect To Future Cash Flows: A Critical Project Report



Discretional Accounting Choices and the Predictive Ability of Accruals With Respect To Future Cash Flows: A Critical Project Report

Introduction

The construction of the bank income had always been at ah higher degree of discretion on the part of managers and justified by a duration cycle with much high risk and encourages through the importance of conveying confidence in the institution and the system. In this article, written by Badertscher, Collins and Lys focus on the discretionary accounting choices made by managers which directly impact on the earnings' ability to predict future firm operating cash flows. This critical analysis will cover up the critical reading and critical writing of this article.

Discussion

The author's thesis and purpose

The main purpose of the author is see that the predication of the future cash flows relative to the restated numbers are less than the original reported to earnings and accruals. Hence, the author has measured the difference between the discretionary accruals choices and restated accruals in the real world. For this purpose the author has assumed that the opportunistic meet-or-beat incentive governs informational incentives and reduces the analytical usefulness of earnings and its mechanism with respect to future cash flows. Moreover, in order to see the manager's choice of the direction and magnitude of discretionary accrual choices. Hence, due to this the result of this study indicates the originality of the accruals that explains the power of the future cash flows to the reported accruals differs in real world.

Analyze the structure of the passage by identifying all main ideas

The main idea of this article is based on three points expressed by the authors, these are as followed: In this article it has been introduces the concept of a discretionary accrual model which captures the relation between cash flows and accruals better than previous models. It provides evidence that firms model miss-classifies nondiscretionary accruals as discretionary, and shows the problems this misspecification causes. Many research has suggest that earnings contain more information than rather primitive constructs like operating cash flows. That is, the correlation between earnings and contemporaneous or future stock returns, and the correlation between earnings and future performance are higher than the correlation between cash flows from operations and these variables. Such improvement in information content is obtained by the use of accruals.

The explanation behind this is that accruals reduce the problems of timing in measuring cash flows over short intervals. In this sense, accruals contain the accounting adjustments necessary to cancel variations related to the operating cash cycle. Nevertheless, since GAAP allows certain discretion in reporting accounting numbers, there is a possibility that accruals contain management's expectations about future cash flows and/or management's intention to manipulate information. There have been several attempts to separate the nondiscretionary and discretionary part of accruals (Guay W., Kothari S.P., Watts, R.L., 1996, pp. 14).

However, these models ignore the relation between cash flows and accruals according ...