Review of Accounting Studies, 4, 231–234 (1999)
1999 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Discussion of “Accruals, Cash Flows and Equity
RICHARD G. SLOAN
School of Business Administration, University of Michigan, Ann Arbor, MI 48109-1234, USA
Accruals are at the very heart of accounting and are the subject of constant debate among
investment professionals. Some academics and practitioners advocate ‘backing out’ ac-
cruals in evaluating corporate performance, encouraging investors to focus on cash ﬂows
rather than earnings. Yet most investors still clearly embrace the earnings number with its
accruals intact, as evidenced by Wall Street’s continued ﬁxation on quarterly EPS results.
The paper by Beaver, Barth, Hand and Landsman (1999, BBHL hereafter) therefore clearly
focuses on an important and contentious topic. The major conclusion reached by BBHL is
that investors should condition on both the cash ﬂow and accrual components of earnings
when forecasting fundamentals and determining ﬁrm value. Using a valuation framework
developed in Ohlson (1999), the authors also show that stock prices act as ifinvestors at least
partially incorporate information in the accrual and cash ﬂows components of earnings.
My main concern with the paper of BBHL is that its incremental contribution does not
become clear. Relative to previous research, BBHL’suse of the Ohlson valuationframework
enables them to more explicitly articulate the links between current cash ﬂows and accruals,
future fundamentals and ﬁrm value. However, at the end of the day, our understanding of
the properties of cash ﬂows and accruals and the extent to which these properties are
reﬂected in stock prices is not enhanced much beyond previous research. I expand on my
concerns below, and ﬁnish with a call for moreresearch in this area, along with some general
suggestions concerning the focus of such research.
1. Forecasting Properties of Cash Flows and Accruals
Previous research has evaluated the forecasting properties of cash ﬂows and accruals with
respect to future earnings (e.g., Sloan, 1996). Working within Ohlson’s valuation frame-
work, BBHL examines the forecasting properties of cash ﬂows and accruals with respect to
future abnormal earnings. Since future realizations of both earnings and abnormal earnings
are undoubtedly ‘value relevant,’ both of the above approaches offer useful insights. How-
ever, a clear advantage of BBHL’s use of abnormal earnings is that Ohlson’s model allows
them to explicate and test the link between future abnormal earnings and ﬁrm value.
Perhaps the most disappointing feature of BBHL is that it makes no attempt to formulate
and test hypotheses about the relative information content of cash ﬂows and accruals.
Instead, the authors argue that the information content of these variables is ‘difﬁcult to