Financial Reporting Quality: Aggregate Accruals
Earnings can be decomposed into cash and accrual components. The accrual component (aggregate accruals) has been found to have less persistence than the cash component, and therefore (1) earnings with higher accrual component are less persistent than earnings with smaller accrual component, all else equal; and (2) the cash component of earnings should receive a higher weighting evaluating company performance.
Balance-Sheet-Based Accruals Ratio
Reynolds American Inc., balance sheet computation of aggregate accruals
US$ in millions
| Dec 31, 2016 | Dec 31, 2015 | Dec 31, 2014 | Dec 31, 2013 | Dec 31, 2012 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 51,095) | 53,224) | 15,196) | 15,402) | 16,557) | |
| Less: Cash and cash equivalents | 2,051) | 2,567) | 966) | 1,500) | 2,502) | |
| Less: Short-term investments | —) | 149) | —) | —) | —) | |
| Operating assets | 49,044) | 50,508) | 14,230) | 13,902) | 14,055) | |
| Operating Liabilities | ||||||
| Total liabilities | 29,384) | 34,972) | 10,674) | 10,235) | 11,300) | |
| Less: Current maturities of long-term debt | 501) | 506) | 450) | —) | 60) | |
| Less: Long-term debt, less current maturities | 12,664) | 16,941) | 4,633) | 5,099) | 5,035) | |
| Operating liabilities | 16,219) | 17,525) | 5,591) | 5,136) | 6,205) | |
| Net operating assets1 | 32,825) | 32,983) | 8,639) | 8,766) | 7,850) | |
| Balance-sheet-based aggregate accruals2 | (158) | 24,344) | (127) | 916) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | -0.48% | 116.98% | -1.46% | 11.03% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Coca-Cola Co. | — | — | — | — | — | |
| Mondelēz International Inc. | — | — | — | — | — | |
| PepsiCo Inc. | — | — | — | — | — | |
| Philip Morris International Inc. | — | — | — | — | — | |
Based on: 10-K (reporting date: 2016-12-31), 10-K (reporting date: 2015-12-31), 10-K (reporting date: 2014-12-31), 10-K (reporting date: 2013-12-31), 10-K (reporting date: 2012-12-31).
1 2016 Calculation
Net operating assets = Operating assets – Operating liabilities
= 49,044 – 16,219 = 32,825
2 2016 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2016 – Net operating assets2015
= 32,825 – 32,983 = -158
3 2016 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × -158 ÷ [(32,825 + 32,983) ÷ 2] = -0.48%
4 Click competitor name to see calculations.
The analysis of financial reporting quality between 2013 and 2016 reveals significant volatility in the balance-sheet-based accruals ratio, closely tied to a substantial expansion of the asset base in 2015.
- Net Operating Assets Trend
- Net operating assets remained relatively stable between 2013 and 2014, shifting from 8,766 million USD to 8,639 million USD. However, a significant increase occurred in 2015, where assets rose to 32,983 million USD, representing a nearly fourfold increase. This elevated level was maintained through 2016 at 32,825 million USD.
- Aggregate Accruals Volatility
- Balance-sheet-based aggregate accruals exhibited extreme fluctuations. After a moderate positive value of 916 million USD in 2013 and a slight negative value of -127 million USD in 2014, accruals spiked to 24,344 million USD in 2015. This figure then reverted sharply to -158 million USD by the end of 2016.
- Accruals Ratio Interpretation
- The balance-sheet-based accruals ratio mirrors the volatility of the aggregate accruals. The ratio moved from 11.03% in 2013 to -1.46% in 2014, before reaching an outlier peak of 116.98% in 2015. By 2016, the ratio stabilized at -0.48%.
The extreme spike in the accruals ratio during 2015 suggests a period of lower earnings quality or the occurrence of a major non-cash transaction, such as a large-scale acquisition, which significantly inflated both net operating assets and aggregate accruals. The subsequent return to a near-zero ratio in 2016 indicates that the factors driving the 2015 anomaly were transitory and that reporting quality returned to a more conservative baseline.
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Cash-Flow-Statement-Based Accruals Ratio
Reynolds American Inc., cash flow statement computation of aggregate accruals
US$ in millions
| Dec 31, 2016 | Dec 31, 2015 | Dec 31, 2014 | Dec 31, 2013 | Dec 31, 2012 | ||
|---|---|---|---|---|---|---|
| Net income | 6,073) | 3,253) | 1,470) | 1,718) | 1,272) | |
| Less: Net cash flows from operating activities | 1,280) | 196) | 1,623) | 1,308) | 1,568) | |
| Less: Net cash flows (used in) from investing activities | 5,078) | (10,005) | (205) | (113) | (54) | |
| Cash-flow-statement-based aggregate accruals | (285) | 13,062) | 52) | 523) | (242) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | -0.87% | 62.76% | 0.60% | 6.30% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Coca-Cola Co. | — | — | — | — | — | |
| Mondelēz International Inc. | — | — | — | — | — | |
| PepsiCo Inc. | — | — | — | — | — | |
| Philip Morris International Inc. | — | — | — | — | — | |
Based on: 10-K (reporting date: 2016-12-31), 10-K (reporting date: 2015-12-31), 10-K (reporting date: 2014-12-31), 10-K (reporting date: 2013-12-31), 10-K (reporting date: 2012-12-31).
1 2016 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × -285 ÷ [(32,825 + 32,983) ÷ 2] = -0.87%
2 Click competitor name to see calculations.
An analysis of the financial reporting quality between 2013 and 2016 reveals significant volatility in the relationship between accrual-based earnings and cash flows. The period is characterized by a massive structural shift in the balance sheet and a corresponding spike in accruals during the 2015 fiscal year.
- Net Operating Assets Trend
- Net operating assets remained relatively stable between 2013 and 2014, hovering around $8.6 billion to $8.7 billion. A substantial increase occurred in 2015, with assets rising to $32,983 million, representing an increase of approximately 282%. This asset base remained largely consistent through 2016 at $32,825 million, indicating a permanent expansion of the operating scale.
- Cash-Flow-Statement-Based Aggregate Accruals
- Aggregate accruals exhibited extreme fluctuations. After remaining low in 2013 ($523 million) and 2014 ($52 million), there was a dramatic surge to $13,062 million in 2015. This trajectory reversed sharply in 2016, where accruals became negative at -$285 million, indicating that cash flow from operations exceeded accrual-based income.
- Accruals Ratio Interpretation
- The accruals ratio provides a measure of earnings quality, where higher ratios typically suggest lower quality due to a greater reliance on non-cash accounting entries. The ratio was low in 2013 (6.30%) and 2014 (0.60%), suggesting strong cash alignment. The 2015 spike to 62.76% represents a significant divergence between reported earnings and cash flow, likely linked to the surge in net operating assets. The subsequent drop to -0.87% in 2016 indicates a normalization of reporting quality and a shift toward cash-heavy earnings.
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