Financial Reporting Quality: Aggregate Accruals
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
CoStar Group Inc., balance sheet computation of aggregate accruals
US$ in thousands
Based on: 10-K (reporting date: 2022-12-31), 10-K (reporting date: 2021-12-31), 10-K (reporting date: 2020-12-31), 10-K (reporting date: 2019-12-31), 10-K (reporting date: 2018-12-31).
1 2022 Calculation
Net operating assets = Operating assets – Operating liabilities
= 3,434,500 – 543,139 = 2,891,361
2 2022 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2022 – Net operating assets2021
= 2,891,361 – 2,872,490 = 18,871
3 2022 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 18,871 ÷ [(2,891,361 + 2,872,490) ÷ 2] = 0.65%
Between 2019 and 2022, a distinct divergence is observed between the growth of net operating assets and the trajectory of balance-sheet-based aggregate accruals. While the asset base expanded steadily, the volume of accruals decreased significantly, leading to a substantial reduction in the accruals ratio.
- Net Operating Assets Trend
- Net operating assets demonstrated a consistent upward trend, increasing from 2,334,862 thousand USD in 2019 to 2,891,361 thousand USD by 2022. The most pronounced growth occurred between 2019 and 2021, followed by a period of relative stabilization in 2022.
- Aggregate Accruals Movement
- Balance-sheet-based aggregate accruals experienced a continuous and steep decline over the four-year period. Starting at 413,336 thousand USD in 2019, the figures fell to 271,300 thousand USD in 2020 and 266,328 thousand USD in 2021, before dropping sharply to 18,871 thousand USD in 2022.
- Accruals Ratio Analysis
- The balance-sheet-based accruals ratio declined precipitously from 19.42% in 2019 to 0.65% in 2022. This contraction indicates that the gap between reported accounting earnings and actual cash flows has narrowed significantly relative to the size of the balance sheet. From a financial reporting quality perspective, this trend suggests an improvement in earnings quality, as reported profits are increasingly backed by cash rather than non-cash accruals.
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Cash-Flow-Statement-Based Accruals Ratio
CoStar Group Inc., cash flow statement computation of aggregate accruals
US$ in thousands
Based on: 10-K (reporting date: 2022-12-31), 10-K (reporting date: 2021-12-31), 10-K (reporting date: 2020-12-31), 10-K (reporting date: 2019-12-31), 10-K (reporting date: 2018-12-31).
1 2022 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × -40,112 ÷ [(2,891,361 + 2,872,490) ÷ 2] = -1.39%
The analysis of cash-flow-statement-based accruals from 2019 to 2022 reveals a significant transition in the relationship between reported earnings and actual cash flows. While net operating assets grew steadily over the period, aggregate accruals experienced a sharp decline, shifting from a positive to a negative position by the end of 2022.
- Net Operating Assets
- A consistent upward trajectory is observed in net operating assets, which increased from US$ 2,334,862 thousand in 2019 to US$ 2,891,361 thousand in 2022. Although the asset base expanded throughout the period, the rate of growth decelerated significantly between 2021 and 2022, suggesting a stabilization in the scale of operating investments.
- Cash-flow-statement-based Aggregate Accruals
- Aggregate accruals demonstrate a pronounced downward trend, falling from US$ 340,936 thousand in 2019 to -US$ 40,112 thousand in 2022. The transition to negative accruals in the final year indicates that cash flow from operations exceeded reported accrual-based earnings, which is typically associated with higher earnings quality and more conservative financial reporting.
- Cash-flow-statement-based Accruals Ratio
- The accruals ratio reflects a substantial contraction, moving from 16.02% in 2019 to -1.39% in 2022. The elevated ratio in 2019 indicated a notable gap where reported earnings were significantly higher than cash flows. The subsequent steady decline and eventual shift to a negative percentage suggest a reduction in the reliance on non-cash accruals to support reported profitability, resulting in a closer alignment between earnings and cash generation.
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