Modelling the accruals process and assessing unexpected accruals*

(i.e., the initiation of abnormal accruals). The difference between reported and underlying
t u, t
income ( CNI CNI ) is abnormal accruals if there is no distortion in reported cash flow.
The main implication from the abnormal accruals model is that abnormal accruals are driven by
a change in accounting policy and forward income growth. Reported income will be distorted
upward when income growth is positive and when there is accounting aggression and/or an
increase in the aggression level. Similarly, there will be a negative distortion in reported income
when income growth is positive and there is conservatism and/or an increase in the conservatism
level. If one restricts the proportion of future underlying income shifted to the current period to
be the same as the proportion of current underlying income shifted to the past (i.e., mt1, t mt,
t1),
the distortion in reported income is totally driven by the growth in income. Under such a
restriction where the level of accounting distortions are constant or permanent, the model yields
the well documented effect that firms tend to understate income when permanent conservatism is
associated with positive growth, with the opposite being true for permanent aggression. 13
3.4 Combining normal and abnormal accruals models
Total accruals consist of abnormal and normal components as follows
t t
TACC CNICFt u, t u, t t u, t u, t
CNI CF CNI CNI CFt CF
The items in the round brackets are the normal accruals while the items in the square brackets are
the abnormal accruals. Abnormal accruals are simply the difference between reported and
underlying income if there is no distortion in total reported cash flow (as is assumed throughout
13 See Penman (2004) for instance; and for more detailed and comprehensive analyses on the impacts of accounting
distortions on performance measures, please refer to Lai (2009).
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