Financial Reporting Quality: Aggregate Accruals

Difficulty: Advanced

Earnings can be decomposed into cash and accrual components. The accrual component (aggregate accruals) has been found to have less persistence than the cash component, and therefore (1) earnings with higher accrual component are less persistent than earnings with smaller accrual component, all else equal; and (2) the cash component of earnings should receive a higher weighting evaluating company performance.


Balance-Sheet-Based Accruals Ratio

Celgene Corp., balance sheet computation of aggregate accruals

USD $ in millions

 
Dec 31, 2017 Dec 31, 2016 Dec 31, 2015 Dec 31, 2014 Dec 31, 2013
Operating Assets
Total assets 30,141  28,086  27,053  17,340  13,378 
Less: Cash and cash equivalents 7,013  6,170  4,880  4,122  3,234 
Less: Marketable securities available-for-sale 5,029  1,800  1,672  3,425  2,453 
Operating assets 18,099  20,116  20,502  9,793  7,691 
Operating Liabilities
Total liabilities 23,220  21,486  21,134  10,815  7,788 
Less: Short-term borrowings and current portion of long-term debt 501  606  545 
Less: Long-term debt, net of discount, excluding current portion 15,838  13,789  14,250  6,266  4,197 
Operating liabilities 7,382  7,197  6,884  3,944  3,047 
Net operating assets1 10,717  12,919  13,618  5,850  4,644 
Balance-sheet-based aggregate accruals2 (2,202) (699) 7,768  1,206 
Ratio
Balance-sheet-based accruals ratio3 -18.63% -5.27% 79.80% 22.98% –%
Benchmarks
Balance-Sheet-Based Accruals Ratio, Competitors
Abbott Laboratories 69.42% -1.06% -3.34% 5.31% –%
AbbVie Inc. -7.02% 25.20% 105.82% -10.63% –%
Allergan PLC 1.78% -21.00% 92.17% 81.99% –%
Amgen Inc. -33.04% -6.85% -4.19% -16.66% –%
Biogen Inc. 7.67% 9.75% 26.50% 17.78% –%
Bristol-Myers Squibb Co. -24.97% -0.82% 9.08% -21.32% –%
Eli Lilly & Co. -5.99% 1.26% -2.72% 6.44% –%
Gilead Sciences Inc. -16.94% 23.56% 38.29% 10.44% –%
Johnson & Johnson 31.51% 5.55% -5.16% -12.84% –%
Merck & Co. Inc. -0.65% -12.97% 6.02% -9.49% –%
Pfizer Inc. 12.36% 4.12% 11.13% -11.14% –%
Regeneron Pharmaceuticals Inc. 33.15% 26.37% 34.77% 17.45% –%
Balance-Sheet-Based Accruals Ratio, Sector
Pharmaceuticals & Biotechnology 8.00% -1.83% 29.02% 0.34% –%
Balance-Sheet-Based Accruals Ratio, Industry
Health Care 8.34% 0.71% 31.81% 2.29% –%

2017 Calculations

1 Net operating assets = Operating assets – Operating liabilities
= 18,099 – 7,382 = 10,717

2 Balance-sheet-based aggregate accruals = Net operating assets 2017 – Net operating assets 2016
= 10,717 – 12,919 = -2,202

3 Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × -2,202 ÷ [(10,717 + 12,919) ÷ 2] = -18.63%

Ratio Description The company
Balance-sheet-based accruals ratio Ratio is found by dividing balance-sheet-based aggregate accruals by average net operating assets. Using the balance-sheet-based accruals ratio, Celgene Corp. deteriorated earnings quality from 2016 to 2017.

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Cash-Flow-Statement-Based Accruals Ratio

Celgene Corp., cash flow statement computation of aggregate accruals

USD $ in millions

 
Dec 31, 2017 Dec 31, 2016 Dec 31, 2015 Dec 31, 2014 Dec 31, 2013
Net income 2,940  1,999  1,602  2,000  1,450 
Less: Net cash provided by operating activities 5,246  3,976  2,484  2,806  2,226 
Less: Net cash used in investing activities (2,891) (1,002) (6,259) (1,438) (529)
Cash-flow-statement-based aggregate accruals 585  (975) 5,377  632  (247)
Ratio
Cash-flow-statement-based accruals ratio1 4.95% -7.35% 55.24% 12.04% –%
Benchmarks
Cash-Flow-Statement-Based Accruals Ratio, Competitors
Abbott Laboratories 12.34% -6.46% 4.27% -4.88% –%
AbbVie Inc. -12.92% 16.02% 59.26% -9.59% –%
Allergan PLC -9.44% -10.08% 45.11% 4.84% –%
Amgen Inc. -22.85% 22.06% 11.81% 7.33% –%
Biogen Inc. 6.65% 12.70% 39.81% 17.50% –%
Bristol-Myers Squibb Co. -28.29% 0.76% 8.10% -13.71% –%
Eli Lilly & Co. -11.43% 5.63% -2.13% 10.71% –%
Gilead Sciences Inc. 28.23% 29.15% 45.78% 6.43% –%
Johnson & Johnson -7.40% 4.68% 7.15% 17.15% –%
Merck & Co. Inc. -13.29% -5.97% -5.73% 7.75% –%
Pfizer Inc. 10.69% -1.06% -5.98% -2.74% –%
Regeneron Pharmaceuticals Inc. 19.22% 13.64% 8.37% 1.33% –%
Cash-Flow-Statement-Based Accruals Ratio, Sector
Pharmaceuticals & Biotechnology -2.28% 1.73% 16.40% 4.81% –%
Cash-Flow-Statement-Based Accruals Ratio, Industry
Health Care 0.42% 2.67% 16.24% 5.88% –%

2017 Calculations

1 Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × 585 ÷ [(10,717 + 12,919) ÷ 2] = 4.95%

Ratio Description The company
Cash-flow-statement-based accruals ratio Ratio is found by dividing cash-flow-statement-based aggregate accruals by average net operating assets. Using the cash-flow-statement-based accruals ratio, Celgene Corp. improved earnings quality from 2016 to 2017.

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