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
Illumina Inc., balance sheet computation of aggregate accruals
US$ in millions
| Dec 31, 2020 | Dec 29, 2019 | Dec 30, 2018 | Dec 31, 2017 | Dec 31, 2016 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 7,585) | 7,316) | 6,959) | 5,257) | 4,281) | |
| Less: Cash and cash equivalents | 1,810) | 2,042) | 1,144) | 1,225) | 735) | |
| Less: Short-term investments | 1,662) | 1,372) | 2,368) | 920) | 824) | |
| Operating assets | 4,113) | 3,902) | 3,447) | 3,112) | 2,722) | |
| Operating Liabilities | ||||||
| Total liabilities | 2,891) | 2,703) | 3,053) | 2,288) | 1,966) | |
| Less: Build-to-suit lease liability | —) | —) | —) | 144) | 223) | |
| Less: Long-term debt, current portion | 511) | —) | 1,107) | 10) | 1) | |
| Less: Long-term debt, excluding current portion | 673) | 1,141) | 890) | 1,182) | 1,048) | |
| Operating liabilities | 1,707) | 1,562) | 1,056) | 952) | 695) | |
| Net operating assets1 | 2,406) | 2,340) | 2,391) | 2,160) | 2,027) | |
| Balance-sheet-based aggregate accruals2 | 66) | (51) | 231) | 133) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 2.78% | -2.16% | 10.15% | 6.34% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| AbbVie Inc. | — | — | — | — | — | |
| Amgen Inc. | — | — | — | — | — | |
| Bristol-Myers Squibb Co. | — | — | — | — | — | |
| Danaher Corp. | — | — | — | — | — | |
| Eli Lilly & Co. | — | — | — | — | — | |
| Gilead Sciences Inc. | — | — | — | — | — | |
| Johnson & Johnson | — | — | — | — | — | |
| Merck & Co. Inc. | — | — | — | — | — | |
| Pfizer Inc. | — | — | — | — | — | |
| Regeneron Pharmaceuticals Inc. | — | — | — | — | — | |
| Thermo Fisher Scientific Inc. | — | — | — | — | — | |
| Vertex Pharmaceuticals Inc. | — | — | — | — | — | |
Based on: 10-K (reporting date: 2020-12-31), 10-K (reporting date: 2019-12-29), 10-K (reporting date: 2018-12-30), 10-K (reporting date: 2017-12-31), 10-K (reporting date: 2016-12-31).
1 2020 Calculation
Net operating assets = Operating assets – Operating liabilities
= 4,113 – 1,707 = 2,406
2 2020 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2020 – Net operating assets2019
= 2,406 – 2,340 = 66
3 2020 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 66 ÷ [(2,406 + 2,340) ÷ 2] = 2.78%
4 Click competitor name to see calculations.
An analysis of the financial reporting quality between 2017 and 2020 reveals a period of volatility in accruals contrasted against a relatively stable base of net operating assets.
- Net Operating Assets Trend
- Net operating assets exhibited a gradual upward trajectory, increasing from US$ 2,160 million in 2017 to US$ 2,406 million in 2020. A minor contraction occurred in 2019, where values dipped to US$ 2,340 million, before resuming growth in the final year of the period.
- Balance-Sheet-Based Aggregate Accruals
- Aggregate accruals demonstrated significant fluctuation over the four-year period. A notable increase occurred between 2017 and 2018, with values rising from US$ 133 million to a peak of US$ 231 million. This was followed by a sharp reversal in 2019, where accruals became negative at -US$ 51 million, before returning to a positive position of US$ 66 million in 2020.
- Balance-Sheet-Based Accruals Ratio
- The accruals ratio, which serves as a proxy for the quality of earnings, mirrored the volatility of the aggregate accruals. The ratio climbed from 6.34% in 2017 to 10.15% in 2018, indicating a higher proportion of non-cash earnings relative to the asset base. This trend inverted in 2019, falling to -2.16%, suggesting that cash flows exceeded reported accrual earnings during that fiscal year. By 2020, the ratio stabilized at 2.78%, indicating a return to a low positive accrual level.
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Cash-Flow-Statement-Based Accruals Ratio
Illumina Inc., cash flow statement computation of aggregate accruals
US$ in millions
| Dec 31, 2020 | Dec 29, 2019 | Dec 30, 2018 | Dec 31, 2017 | Dec 31, 2016 | ||
|---|---|---|---|---|---|---|
| Net income attributable to Illumina stockholders | 656) | 1,002) | 826) | 726) | 463) | |
| Less: Net cash provided by operating activities | 1,080) | 1,051) | 1,142) | 875) | 687) | |
| Less: Net cash (used in) provided by investing activities | (554) | 745) | (1,813) | (214) | (515) | |
| Cash-flow-statement-based aggregate accruals | 130) | (794) | 1,497) | 65) | 290) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | 5.48% | -33.57% | 65.79% | 3.10% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| AbbVie Inc. | — | — | — | — | — | |
| Amgen Inc. | — | — | — | — | — | |
| Bristol-Myers Squibb Co. | — | — | — | — | — | |
| Danaher Corp. | — | — | — | — | — | |
| Eli Lilly & Co. | — | — | — | — | — | |
| Gilead Sciences Inc. | — | — | — | — | — | |
| Johnson & Johnson | — | — | — | — | — | |
| Merck & Co. Inc. | — | — | — | — | — | |
| Pfizer Inc. | — | — | — | — | — | |
| Regeneron Pharmaceuticals Inc. | — | — | — | — | — | |
| Thermo Fisher Scientific Inc. | — | — | — | — | — | |
| Vertex Pharmaceuticals Inc. | — | — | — | — | — | |
Based on: 10-K (reporting date: 2020-12-31), 10-K (reporting date: 2019-12-29), 10-K (reporting date: 2018-12-30), 10-K (reporting date: 2017-12-31), 10-K (reporting date: 2016-12-31).
1 2020 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × 130 ÷ [(2,406 + 2,340) ÷ 2] = 5.48%
2 Click competitor name to see calculations.
The analysis of financial reporting quality reveals a period of significant volatility in accruals between 2017 and 2020, contrasting with a relatively stable base of net operating assets.
- Net Operating Assets Trend
- Net operating assets remained consistent over the four-year period, increasing from US$ 2,160 million in 2017 to US$ 2,406 million by 2020. This stability indicates a steady asset base, with only a minor contraction observed in 2019 before returning to growth.
- Aggregate Accruals Volatility
- Cash-flow-statement-based aggregate accruals exhibited extreme fluctuations. After a modest US$ 65 million in 2017, accruals surged to US$ 1,497 million in 2018. This was followed by a sharp reversal to a negative US$ 794 million in 2019, before normalizing to US$ 130 million in 2020.
- Accruals Ratio and Earnings Quality
- The accruals ratio mirrors the volatility of aggregate accruals, shifting from 3.10% in 2017 to a peak of 65.79% in 2018. Such a high ratio typically suggests a significant divergence between accrual-based earnings and cash flows, potentially indicating lower earnings quality during that period. The subsequent shift to -33.57% in 2019 suggests a period where cash flows significantly exceeded accruals. By 2020, the ratio stabilized at 5.48%, returning toward the baseline levels established at the beginning of the period.
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