The profitability and consistency of the accounting abnormal accruals anomaly in UK firms

Ahmad, ALA

Abstract

This research explores new evidence on the profitability, consistency and potential
explanations of the accruals anomaly. We extend prior research into the association
between earnings and share price by discrirninating between firms on the basis of the
abnormal accruals contained in the reported operating profits. We investigate the
accounting abnormal accruals enigma using U.K company data for the period 1968-
2005 to see whether companies reporting incomes consisting of the highest [lowest]
operating abnormal accruals as a proportion of total assets significantly earn lower
[higher] returns than the generality of the companies. We define a firm's abnormal
accrual as the difference between its actual and normal total accruals. Total accruals
are calculated as the change in non-cash working capital before income taxes payable
less total depreciation expense. The themes of this thesis are two-fold.
First, the time-series version of the Modified Jones Model is employed to decompose
total operating accruals as they appear on the sample companies' financial statements
into normal and abnormal accruals.
Second, an empirical examination of the profitability and consistency of the abnormal
accruals anomaly is undertaken. Abnormal returns for abnormal accruals deciles are
estimated using a range of tests: the market-, the size-, the book-to-market- and the
size-and-book-to-market-adjusting tests.
Our abnormal returns estimates for the abnormal accruals deciles show evidence that
the abnormal accruals anomaly in the UK is driven particularly by the highest
abnormal accruals firms with significant negative abnormal returns over three years of
about 4-5% per annum. Potential risk explanations for the observed accruals anomaly
based on variety of tests including the use of the Fama and French three factor model
are provided. The findings indicate that the abnormal accruals anomaly is robust after
controlling for the risk factors. Therefore, the implication of this study is to short sell
those shares in the highest abnormal accruals decile or, alternatively, to avoid buying
them.

Citation

Ahmad, A. The profitability and consistency of the accounting abnormal accruals anomaly in UK firms. (Thesis). University of Salford

• Thesis Type: Thesis
• Deposit Date: Jul 21, 2011
• Publicly Available Date: Jul 21, 2011
• Award Date: Jan 1, 2009