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
Air Products & Chemicals Inc., balance sheet computation of aggregate accruals
US$ in thousands
| Sep 30, 2020 | Sep 30, 2019 | Sep 30, 2018 | Sep 30, 2017 | Sep 30, 2016 | Sep 30, 2015 | ||
|---|---|---|---|---|---|---|---|
| Operating Assets | |||||||
| Total assets | 25,168,500) | 18,942,800) | 19,178,300) | 18,467,200) | 18,055,300) | 17,438,100) | |
| Less: Cash and cash items | 5,253,000) | 2,248,700) | 2,791,300) | 3,273,600) | 1,501,300) | 206,400) | |
| Less: Short-term investments | 1,104,900) | 166,000) | 184,700) | 404,000) | —) | —) | |
| Operating assets | 18,810,600) | 16,528,100) | 16,202,300) | 14,789,600) | 16,554,000) | 17,231,700) | |
| Operating Liabilities | |||||||
| Total liabilities | 12,725,400) | 7,554,500) | 8,002,000) | 8,281,700) | 10,841,900) | 10,057,000) | |
| Less: Short-term borrowings | 7,700) | 58,200) | 54,300) | 144,000) | 935,800) | 1,494,300) | |
| Less: Current portion of long-term debt | 470,000) | 40,400) | 406,600) | 416,400) | 371,300) | 435,600) | |
| Less: Long-term debt, excluding current portion | 7,132,900) | 2,907,300) | 2,967,400) | 3,402,400) | 4,918,100) | 3,949,100) | |
| Less: Long-term debt, related party | 297,200) | 320,100) | 384,300) | —) | —) | —) | |
| Operating liabilities | 4,817,600) | 4,228,500) | 4,189,400) | 4,318,900) | 4,616,700) | 4,178,000) | |
| Net operating assets1 | 13,993,000) | 12,299,600) | 12,012,900) | 10,470,700) | 11,937,300) | 13,053,700) | |
| Balance-sheet-based aggregate accruals2 | 1,693,400) | 286,700) | 1,542,200) | (1,466,600) | (1,116,400) | —) | |
| Financial Ratio | |||||||
| Balance-sheet-based accruals ratio3 | 12.88% | 2.36% | 13.72% | -13.09% | -8.93% | — | |
| Benchmarks | |||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | |||||||
| Linde plc | — | — | — | — | — | — | |
| Sherwin-Williams Co. | — | — | — | — | — | — | |
Based on: 10-K (reporting date: 2020-09-30), 10-K (reporting date: 2019-09-30), 10-K (reporting date: 2018-09-30), 10-K (reporting date: 2017-09-30), 10-K (reporting date: 2016-09-30), 10-K (reporting date: 2015-09-30).
1 2020 Calculation
Net operating assets = Operating assets – Operating liabilities
= 18,810,600 – 4,817,600 = 13,993,000
2 2020 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2020 – Net operating assets2019
= 13,993,000 – 12,299,600 = 1,693,400
3 2020 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 1,693,400 ÷ [(13,993,000 + 12,299,600) ÷ 2] = 12.88%
4 Click competitor name to see calculations.
An analysis of the financial reporting quality indicates significant volatility in accruals relative to net operating assets between 2016 and 2020. The period is characterized by a transition from negative to positive aggregate accruals, suggesting a shift in the relationship between reported earnings and cash flows.
- Net Operating Assets Evolution
- Net operating assets exhibited a general upward trajectory, increasing from US$ 11,937,300 thousand in 2016 to US$ 13,993,000 thousand by 2020. Despite a contraction in 2017 to US$ 10,470,700 thousand, the overall trend reflects an expansion of the operational asset base.
- Aggregate Accruals Dynamics
- Balance-sheet-based aggregate accruals shifted from negative values in 2016 and 2017 to positive values from 2018 onward. A notable reversal occurred between 2017 and 2018, where accruals moved from negative US$ 1,466,600 thousand to positive US$ 1,542,200 thousand. By 2020, aggregate accruals reached a period high of US$ 1,693,400 thousand, indicating that reported earnings were increasingly exceeding cash flows from operations.
- Accruals Ratio Interpretation
- The balance-sheet-based accruals ratio demonstrated substantial fluctuation, moving from -8.93% in 2016 to a low of -13.09% in 2017. A sharp pivot occurred in 2018, with the ratio climbing to 13.72%, followed by a correction to 2.36% in 2019 and a subsequent increase to 12.88% in 2020. The transition from negative to positive ratios suggests a change in the quality of earnings, moving from a period of high cash flow relative to accruals to a period of higher accrual accumulation relative to the asset base.
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Cash-Flow-Statement-Based Accruals Ratio
Air Products & Chemicals Inc., cash flow statement computation of aggregate accruals
US$ in thousands
| Sep 30, 2020 | Sep 30, 2019 | Sep 30, 2018 | Sep 30, 2017 | Sep 30, 2016 | Sep 30, 2015 | ||
|---|---|---|---|---|---|---|---|
| Net income attributable to Air Products | 1,886,700) | 1,760,000) | 1,497,800) | 3,000,400) | 631,100) | 1,277,900) | |
| Less: Cash provided by operating activities | 3,264,700) | 2,969,900) | 2,554,700) | 2,534,100) | 2,707,400) | 2,437,800) | |
| Less: Cash used for investing activities | (3,560,000) | (2,113,400) | (1,649,100) | (1,417,700) | (972,000) | (1,599,700) | |
| Cash-flow-statement-based aggregate accruals | 2,182,000) | 903,500) | 592,200) | 1,884,000) | (1,104,300) | 439,800) | |
| Financial Ratio | |||||||
| Cash-flow-statement-based accruals ratio1 | 16.60% | 7.43% | 5.27% | 16.82% | -8.84% | — | |
| Benchmarks | |||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | |||||||
| Linde plc | — | — | — | — | — | — | |
| Sherwin-Williams Co. | — | — | — | — | — | — | |
Based on: 10-K (reporting date: 2020-09-30), 10-K (reporting date: 2019-09-30), 10-K (reporting date: 2018-09-30), 10-K (reporting date: 2017-09-30), 10-K (reporting date: 2016-09-30), 10-K (reporting date: 2015-09-30).
1 2020 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × 2,182,000 ÷ [(13,993,000 + 12,299,600) ÷ 2] = 16.60%
2 Click competitor name to see calculations.
The analysis of financial reporting quality from 2016 to 2020 reveals significant fluctuations in the relationship between accruals and net operating assets. While net operating assets followed a general upward trajectory, the aggregate accruals exhibited high volatility, which directly impacted the stability of the accruals ratio over the five-year period.
- Net Operating Assets
- A general growth trend is observed in net operating assets, which increased from $11.94 billion in 2016 to $13.99 billion in 2020. This growth was interrupted by a decline in 2017, where assets fell to $10.47 billion, before recovering and expanding consistently through 2020.
- Cash-flow-statement-based Aggregate Accruals
- Aggregate accruals shifted from a negative position of -$1.10 billion in 2016 to a positive peak of $2.18 billion in 2020. The most substantial transition occurred between 2016 and 2017, followed by a period of relative moderation in 2018 and 2019, and a final sharp increase in the 2020 fiscal year.
- Cash-flow-statement-based Accruals Ratio
- The accruals ratio demonstrates marked instability, moving from -8.84% in 2016 to 16.82% in 2017. After this peak, the ratio moderated to 5.27% in 2018 and 7.43% in 2019, indicating a period of improved alignment between reported earnings and cash flows. However, the ratio returned to a high of 16.60% by September 30, 2020, suggesting a resurgence of non-cash components in the reported earnings relative to the asset base.
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