Modelling the accruals process and assessing unexpected accruals*

If there is no deviation in operating policies but the income of the benchmark firms is non-
neutral (as in the third row of Table 4), the unexpected accruals will be contaminated by the
amount of this distortion. In particular, firm j‟s unexpected accruals capture the deviation in firm
j‟s accounting policy from the benchmark firms, rather than the full amount of abnormal accruals
attributed to the firm‟s accounting policy. The classification of firm j as aggressive or
conservative is not relative to an otherwise unbiased accounting policy but it is relative to its
benchmark firms (which can be its own time-series history or cross-sectional peers). If the
income distortion of the benchmark firms is negative (i.e., the benchmark firms are conservative),
unexpected accruals will be biased upward relative to abnormal accruals (as in cell 6). Likewise,
unexpected accruals will be biased downward when the income distortion of the benchmark
firms is positive (as in cell 3). Moreover, the magnitude of these upward or downward biases will
equal the amount of the income distortion of the benchmark firms ( AbACC ).
Finally, if there is a deviation in operating policies for firm j and the income of benchmark firms
is distorted, the bias in firm j‟s unexpected accruals will be a function of these two factors. A
positive distortion in the benchmark firms‟ income associated with a negative deviation in
operating policies between firm j and the benchmark firms will unambiguously bias unexpected
accruals downward (as in the case of cell 1 in Table 4). Likewise, a negative distortion in the
benchmark firms‟ income associated with a positive deviation in operating policies will bias
unexpected accruals upward (as in the case of cell 9 in Table 4). The magnitudes of these biases
in firm j’s unexpected accruals will be equal to the amount of the income distortion of the
benchmark firms plus the amount of the deviation in firm j‟s operating policies.
27