 | | | 7 pages | | | 10-06-2009 | | |  |
| | Not evaluated | | |
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A critical analysis of the following research paper: "The market pricing of accruals quality, the paper sustains that the quality of accruals is priced by the financial markets.
The pertinence of the research can be evaluated by questioning to what extent, from a methodological and theoretical point of view, accruals quality has an impact on the opportunity cost of capital.
We firstly summarize the strengths of the research paper; this analysis allows us to then identify the weaknesses of the empirical method in the second part of our paper, finally, we comment upon the limitations of the theoretical approach.
Unlike cash accounting, in which transactions are registered only when flows are paid or received, accrual accounting respects the matching principle and economic events are recognised when transactions occur rather than when payment is made. Accruals quality is the ability to estimate future cash inflows and outflows (as well as changes in revenues and Plant Property & Equipment) and allocate them to the different periods (prior, current and future); its measure is the mapping between accounting earnings and financial profits. The smaller the difference between net incomes and cash flows, the better the judgement. The nearer to the realizations the expectations are, the lower the residuals magnitude is. The more abnormal or anomalous accruals there are, the poorer the accrual quality is. (...)
Introduction
1. Synthesis of strengths
A. Accruals quality has an impact on the information risk and the cost of capital
B. Innate accruals quality has a larger impact than discretionary accruals quality has
2. Methodological weaknesses
A. The specific sample cannot be applied generally
B. Hypotheses and methods are questionable
3. Theoretical limitations
A. Only the systematic component of earning quality risk contributes to the equity risk premium
B. The relation between accruals quality and cost of capital depends on the fundamental risk
C. Accruals quality is neither a priced risk factor nor a determinant of the cost of capital
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