The impact of accounting conservatism on the differential information content of cash flows and accruals.

Abstract

The objective of this study is to examine the relation between the differential information content of operating accruals and accounting conservatism. Feltham and Ohlson's (1995) framework suggests that as conservatism increases, so will the information content of operating accruals relative to cash flows. Feltham and Ohlson (1995) define conservatism as recording operating assets at something less than their market values. Thus, I estimate a 'conservatism score' to proxy for the relative degree of understatement in firms' operating assets.

To isolate the differential information content of operating accruals relative to cash flows, I use a returns model derived from Feltham and Ohlson's (1995) model of firm value. Findings of a positive association between accounting conservatism and the differential return-response to operating accruals support this implication from Feltham and Ohlson's (1995) framework.

Additional analysis shows that the conservatism score used in this study is positively correlated with market-to-book which is also used in the literature as a proxy for conservatism.