Accruals Model

Accruals is the term that the accounting recognition of assets and liabilities that have not yet been realized as a cash flow. By the accruals enable revenue or expenses to be recognized before payment occurs. The purpose of this concept is to make sure that all revenues and costs are recorded in the appropriate statement at the right time.   

Mathematically we know that  TAt = NIt – CFOt

So, the total accruals are the difference between Net Income and Cash Flow from Operation at a time t.

And these total accruals are decomposed in Discretionary accruals & Non-discretionary accruals which are denoted as DA &NDA.

DA: Discretionary Accruals are adjustments to cash flows selected by the manager. DA can be calculated if we know the NDA.

DAt = Accrualst  –  NDAt

NDA: Non-discretionary accruals are accounting adjustments to the firms cash flows mandated by accounting standard-setting bodies. Such as depreciation, obligation of lease financing.  

Accruals Model or Non-discretionary accruals models by the researchers or how can we determine Discretionary accruals or Non-discretionary accruals are as below:

1.      Healy(1985): Nondiscretionary accruals represent as the mean total accruals from the estimation period. 

NDAt  = Σ TAt / Tt

DAt  = TAt – NDAt

2.      DeAngelo(1986): This model uses last period’s total accruals as the measure of nondiscretionary accruals. Thus the, the DeAngelo model for non discretionary accruals is :

NDAt   = TAt-1
DAt = TAt   – NDA

3.      Dechow and Sloan(1991)

NDAt =r1 + r2 median1 (TAt)

DAt=NDAt-TAt

4.      Jones(1991) proposes a model that relaxes the assumption that nondiscretionary accruals are constant.

TAt / At-1=a0(1/ At-1)+a1(∆REVt / At-1) + a2(PPEt  / At-1) +ξt

DAt = (TAt / At-1) – [a0(1/ At-1) + a1(∆REVt / At-1) + a2(PPEt  / At-1)]

5.      Dechow (1995): Modified Jones model have a highest power to detecting earnings management. And use the modified Jones model.

TAt / At-1= a0(1/ At-1)+a1(∆REVt - ∆AR t / At-1) + a2(PPEt  / At-1) +ξt

DAt = (TAt / At-1) – [a0(1/ At-1) + a1(∆REVt  - ∆AR t   / At-1) + a2(PPEt  / At-1)]