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. In this paper, we examine this implicit assumption along three dimensions. First, we argue that the relation 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, we provide evidence that the assumption of a uniform accrual-generating process is violated in industries whose firms' accrual determinants are highly dispersed. Third, we document some implications of violating the assumption of a uniform accrual-generating process. Firms in industries with high variations in accrual determinants are likely to have large absolute abnormal accruals. We 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 accrual-generating processes