Financial Accounting Blog

Thursday, March 04, 2004

Newswise cites research from the University of Washington that indicates companies are pumping up accruals to make them look better before a public stock offering. The swells then revert back to normal levels soon thereafter.
Our research shows that accruals are unusually large before a sale," said University of Washington accounting professor Steve Sefcik, who conducted the study with Business School colleagues Paul Malatesta and Larry DuCharme. Accruals reflect the difference between reported earnings and cash flows, and generally accepted accounting principles (GAAP) allow firms some discretion. Under GAAP, earnings numbers that corporations report to investors can differ in both magnitude and timing from the actual net cash flows that companies experience.

"Firms that manipulate their earnings prior to stock offerings deceive investors, who in turn form overly-optimistic expectations regarding future post-issue earnings," said Malatesta. "These findings strongly suggest that investors should consider the quality of reported earnings and not just their magnitude. They should read the footnotes to the financial statements, and pay attention to cash flows as well as earnings."