Modelling the accruals process and assessing unexpected accruals*

flow associated with income recognised in the past, current or future periods (C). 3 In short, NOA
is increased by OI and reduced by free cash flow.
NFO identity: NFE is comprehensive financing expense (net of financing income). NFO includes
loans, income tax liabilities, preference shares, investments on marketable securities, and
minority interests. It is increased by financing expenses incurred but reduced by actual payment
of financing expenses and principal repayments.
CSE identity: CNI is comprehensive income. This identity can also be obtained if one combines
cash, NOA, and NFO identities. It asserts that owner‟s equity in a firm is increased by income
and reduced by net distributions to shareholders.
2.2 Accrual calculation and the reconciliation between indirect and direct methods
The key difference between accrual and cash basis accounting lies in their timing of recognition
(Statement of Financial Accounting Concepts, No. 6 Paragraph 144). Cash accounting
recognizes a transaction when the associated cash flow is realized rather than expected. As a
result, the change in net operating assets in the NOA identity and the change in net financial
t
obligation in NFO identity Table 1 are both zero under cash accounting (i.e., NOA 0and t
NFO 0 ), where the subscript c denotes cash accounting. 4 This associated with the basic
c
3 According to Dechow and Dichev (2002), Ct consists of
t
t 1 t
t 1
, C , and
t
C t
t
t
. C offsets the cash transactions
t
t 1
recognized in OI. C t 1
reduces NOA
t 1
when earnings recognized in the past are received. C , cash flows received
for earnings to be recognized in future periods, will create operating liability that reduces NOA.
4 This is because C=OIB, I = DA, and F=NFE under cash accounting.
C
t
c
9