The Impact of a Heterogeneous Accrual-Generating Process on Empirical Accrual Models

The cross-sectional approach that is typically used to estimate accrual models implicitly assumes that firms within the same industry have a homogeneous accrual-generating process (AGP). In this article, the authors examine this implicit assumption along three dimensions. First, they argue that the relationship between working-capital accruals and changes in sales is more complex than portrayed by existing empirical accrual models. In addition to sales changes, accruals are also affected by accrual determinants such as firms' inventory and credit policies. Second, the authors provide evidence that the assumption of a uniform AGP is violated in industries whose firms' accrual determinants are highly dispersed. Third, they document some implications of violating the assumption of a uniform AGP. Firms in industries with high variations in accrual determinants are likely to have large absolute abnormal accruals. The authors show that the previously documented increase in the absolute level of abnormal accruals over time could be attributed, in part, to the increased heterogeneity in industries with respect to their AGPs.