The Adjustment Process of Accruals: Empirical Evidence and Implication for Accrual Research

This study analyzes the intertemporal behavior of accruals and uses the results to offer some perspectives on models of accruals. Separate adjustment rates are estimated for total and managed accruals and further compared to assess the influence of managers on accrual adjustment. Analysis is further performed to test whether there is an industry-specific adjustment rate for either total or managed accruals. The results show that both the total and managed accruals follow a partial adjustment process rather than a pure-adjustment or random-walk process. Nonetheless, managed accruals exhibit longer adjustment length than total accruals in each industry sample. In addition, total and managed accruals appear to follow certain adjustment patterns that are industry-specific, consistent with the view that common industry practices and norms lead to benchmark adjustment rates to which industry firms conform. Based on the results showing that accruals exhibit lagged and industry-specific adjustments, an extension of the modified Jones model is proposed. The extended model incorporates lagged accruals and an industry accrual index in an attempt to exploit the lagged-adjustment and industry effects and, in that context, improve the temporal classification of accrual innovations. Simple tests show that the extended model achieves substantial improvements in specification over the modified Jones model.