Do Analysts and Auditors Use Information in Accruals?

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Table of Contents

Introduction
The hypothesis development
Data and Results
Conclusions
Works Cited

Introduction

In the current economic environment, there are a number of antecedents affecting the analysts and auditors’ forecasts concerning the economic performance of a particular company. According to Bradshaw, Richardson, and Sloan, there is a strong association between the high accruals of a particular company and the earnings problems caused by earnings management in that company (45). Overall, one of the common interpretations of such correlation refers to the linkage between the analysts and auditors’ forecasts and earnings management practices aimed at meeting the expectations of those forecasts.

For that reason, it is important to examine various factors that can be linked to the reasons and explanations of how those forecasts can affect the future performance of a particular company, including whether the connotations of the forecasts represent the incentives for earnings management or there are some other internal and external reasons predetermining the practices of earnings management in financial accruals among various companies’ executives.

The hypothesis development

It is important to point out the fact that GAAP violations are documented in auditor turnover, which is why it is significant not to confuse the role of auditors’ statements. However, in the case of analysts’ forecast, there is a certain level of expectations applied to the companies. In case the executives of those companies are not able to perform good enough to reach that benchmark, there is a strong possibility of lowering of the stock prices, as well as executives losing some of their benefits.

However, in the situation, when a company introduces some practices of earnings management, especially, by using financial accruals, to meet the analysts’ expectations, the consequences relating to the company’s performance and earnings problems are also highly possible. The standard approach to the incentives concerning analysts and auditors’ forecasts affecting the practices of earnings management and, as a result, negatively influencing the company’s performance, has several important factors. Firstly, the expectations that the analysts and other outside audiences define the approaches used by the firms’ managers who practice earnings management.

Among the most common cases of earnings management, there is an approach, in which the company’s performance does not reach the threshold of expectations, and the managers are likely ‘to borrow’ the profits from the upcoming fiscal periods. However, there is also an opposite variant of GAAP violation, when the performance of the company is expected to be lower than it is in reality, and the managers can delay the earnings reporting.

However, Bradshaw, Richardson, and Sloan also offer the third explanation of such interdependence, suggesting that the incompetence of analysts and auditors’ forecasts can result in financial reporting that involves unrealistic prognosis and demands that could not be otherwise expected from a particular company (47).

Nevertheless, Bradshaw, Richardson, and Sloan claim that there is a body of evidence not compliant with the idea that executives and their financial decisions are affected by the analysts and auditors’ forecasts to such an extent, suggesting that “investors respond to current earnings without fully appreciating the current accounting choices for future earnings and cash flow” (47). Thus, the main hypothesis is that errors in auditors’ forecasts show no intermediate linkage to the future cash flows that are primarily associated with financial accruals.

For that reason, various scenarios of managerial decisions and investors’ choices should have included different variables, such as earnings persistence, accrual reliability, accrual relevance, a degree to which earnings are managed, stock prices, recognition of sales revenues, etc. in order to be associated with the analysis and forecasts of auditors since they are mainly based on the accruals. Moreover, levels of accruals can be linked to the auditor’s change (Bradshaw, Richardson, and Sloan 50).

Data and Results

The most of the data gathered by Bradshaw, Richardson, and Sloan includes the financial statements of Compustat database (51). Among the required parameters used for the analysis, there were such metrics as “increase in accounts receivable, increase in inventory, decrease in accounts payable and accrued liabilities, decrease in accrued income taxes”, and either decrease or increase in the assets and liabilities (Bradshaw, Richardson, and Sloan 51).

The analysis showed that GAAP violations are likely to be linked to a variety of accruals, but in terms of auditing, there is a correlation noticed by Bradshaw, Richardson, and Sloan that those violations are compliant with increased auditor turnover (65). Such correlation was confirmed by the test of the relation between various accruals and auditors’ opinions. Finally, the results confirm the hypothesis that investors are not likely to expect the negative consequences regardless of the current financial reporting. The linkage of using earnings management and change of an auditor is a typical pattern, whereas correlation between forecasts and investors’ decisions is negative.

Conclusions

Overall, earnings management practices are not directly affected by the auditors and analysts’ forecasts but rather executives act out of the need to misallocate the resources. The correlation between change of an auditor and using earnings management to increase the stock prices is more substantial than between forecasts and investors’ decisions.

Works Cited

Bradshaw, Mark, Scott Richardson, and Richard Sloan. “Do Analysts and Auditors Use Information in Accruals?” Journal of Accounting Research 39.1 (2001): 45-74. Print.

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Do Analysts and Auditors Use Information in Accruals?

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