Modelling the accruals process and assessing unexpected accruals*

These restrictions respectively imply that (a) there is no change in accrual policy and profit
margin of benchmark firms between period t–1 and t, (b) the deferred component of normal
working capital accruals is zero (i.e., deferred expenses and revenue are zero), and there is no
distortion in the working capital accruals of the benchmark firms, and (c) there is no distortion in
the benchmark firms‟ depreciation expenses. Under these restrictions, the Jones model
unexpected accruals for firm j will be totally attributed to firm j‟s heterogeneity in parameters.
All the implications discussed in the encompassing model will apply.
However, if any of the 2, t 1,
t,
3, t 0
, and 5, t 0
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restrictions do not hold, the Jones model
will be mis-specified and suffer from correlated omitted variable bias. Specifically, one period
ahead revenue growth, one period ahead revenue, and current non-current operating assets are
the relevant variables omitted from the model, and they will be captured by the disturbance term
t, j.
Since revenue is likely to be serially correlated with past revenue, the estimate of 1,t is
likely to be biased. Similarly, 4,t is likely to be biased as non-current operating assets are likely
to be serially correlated. The direction of this omitted variable bias will be determined by the
(positive or negative) signs of 2,t , 3,t , and 5,t and the correlation between the omitted
variables and the included variables (see Greene 2000 for details).
If the omitted variables do not correlate with the included variables, the parameters 1,t and 4,t
will not be biased. However, they will still contaminate the Jones model unexpected accruals,