The role of accrual estimation errors to determine accrual and earnings quality

Managers, investors and security analysts all pay special attention to the bottom line of income statements and they miss significant information included in accruals about the quality of earnings. A considerable portion of the earnings-quality literatures examines the possibility of using the accruals to shift reported income among fiscal periods. One of the main roles of working-capital accruals is to adjust the recognition of cash flows. This paper focuses on earnings quality by examining the working-capital accruals quality using the method of Dechow and Dichev (2002). The role of accrual estimation errors is essential and the result shows that the quality of accruals and earnings can decrease the magnitude of estimation error in accruals. To investigate the role of accruals, an empirical measure of accrual quality is driven to find the residuals from firm-specific regressions of changes in working capital and future cash flow from operations. The paper contributes to the literature on accruals quality by focusing on the quality of some working-capital items and visible firm characteristics and the result shows that the measure of accrual quality which is used in this paper is positively related to earnings persistence based on the UK data