The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition

Authors


  • We are grateful for comments from Mary Barth, Sudipta Basu, Philip Berger (Editor), Mark Bradshaw, Peter Easton, Richard Frankel, Andrew Leone, Scott Richardson, an anonymous referee, and seminar participants at the 2005 Journal of Accounting Research Conference, Emory University, Harvard Business School, and London Business School. Ball gratefully acknowledges financial support from the University of Chicago, Graduate School of Business.

ABSTRACT

We investigate the role of accrual accounting in the asymmetrically timely recognition (incorporation in reported earnings) of gains and losses. Timely recognition requires accruals when it precedes complete realization of the gains and losses in cash. We show that nonlinear accruals models incorporating the asymmetry in gain and loss recognition (timelier loss recognition, or conditional conservatism) offer a substantial specification improvement, explaining substantially more variation in accruals than equivalent linear specifications. Conversely, conventional linear accruals models, by omitting the loss recognition asymmetry, exhibit substantial attenuation bias and offer a comparatively poor specification of the accounting accrual process. Linear specifications also understate the ability of current earnings to predict future cash flows. These findings have implications for our understanding of accrual accounting and conservatism, as well as for researchers estimating discretionary accruals, earnings management, and earnings quality.

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