Accrual Accounting Case Study

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Q3 Accrual accounting is an accounting method that recognizes economic events regardless of when cash transactions occur in order to measure the performance and position of a company. The general idea is that economic events are matching revenues to expenses to recognize which is the matching principle at the time in which the transaction occurs rather than when payment is made (or received). This method allows combining the current cash inflows or outflows with future expected cash inflows or outflows to give a more accurate picture of a company's current financial condition. Accrual accounting is considered to be the standard accounting practice for most companies with the exception of very small operations. This method provides a more …show more content…

This is a common occurrence in the services industry, where a project may issue an invoice at the end of the project to involve billable services for several months. Accrued revenue is usually listed in the current assets section of the balance sheet in an accrued receivables account. Ohlson (1995) and Feltham and Ohlson (1995), show that future profitability and firm value depend on growth in net operating assets as well as current profiability. They can disaggregate growth in net operating assets into two components which are accruals and growth in long-term net operating assets—just as they can disaggregate profitability into accruals and cash flows from operations. Prior research on the persistence and valuation of cash flows vs accruals focuses on the role of accruals as a component of profiability, but overlooks the role of accruals as a component of growth in net operating assets. Their study probes the extent to which the differential persistence and valuation of accruals documented in prior research can be explained by the role of accruals as a component of growth in net operating assets. In other words, they investigate whether the differential persistence and apparent mispricing of accruals that Sloan (1996) documents apply more broadly to growth in net operating

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