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
Allergan Inc., balance sheet computation of aggregate accruals
US$ in thousands
| Dec 31, 2014 | Dec 31, 2013 | Dec 31, 2012 | Dec 31, 2011 | Dec 31, 2010 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 12,415,700) | 10,574,300) | 9,179,300) | 8,508,600) | 8,308,100) | |
| Less: Cash and equivalents | 4,911,400) | 3,046,100) | 2,701,800) | 2,406,100) | 1,991,200) | |
| Less: Short-term investments | 55,000) | 603,000) | 260,600) | 179,900) | 749,100) | |
| Operating assets | 7,449,300) | 6,925,200) | 6,216,900) | 5,922,600) | 5,567,800) | |
| Operating Liabilities | ||||||
| Total liabilities | 4,652,700) | 4,104,800) | 3,316,700) | 3,176,200) | 3,527,000) | |
| Less: Notes payable | 72,100) | 55,600) | 48,800) | 83,900) | 28,100) | |
| Less: Convertible notes | —) | —) | —) | —) | 642,500) | |
| Less: Long-term debt, excluding current maturities | 2,085,300) | 2,098,300) | 1,512,400) | 1,515,400) | 1,534,200) | |
| Operating liabilities | 2,495,300) | 1,950,900) | 1,755,500) | 1,576,900) | 1,322,200) | |
| Net operating assets1 | 4,954,000) | 4,974,300) | 4,461,400) | 4,345,700) | 4,245,600) | |
| Balance-sheet-based aggregate accruals2 | (20,300) | 512,900) | 115,700) | 100,100) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | -0.41% | 10.87% | 2.63% | 2.33% | — | |
| 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: 2014-12-31), 10-K (reporting date: 2013-12-31), 10-K (reporting date: 2012-12-31), 10-K (reporting date: 2011-12-31), 10-K (reporting date: 2010-12-31).
1 2014 Calculation
Net operating assets = Operating assets – Operating liabilities
= 7,449,300 – 2,495,300 = 4,954,000
2 2014 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2014 – Net operating assets2013
= 4,954,000 – 4,974,300 = -20,300
3 2014 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × -20,300 ÷ [(4,954,000 + 4,974,300) ÷ 2] = -0.41%
4 Click competitor name to see calculations.
The analysis of balance-sheet-based accruals reveals a period of relative stability followed by significant volatility between 2013 and 2014. Net operating assets grew steadily from US$ 4,345,700 thousand in 2011 to a peak of US$ 4,974,300 thousand in 2013, before slightly contracting to US$ 4,954,000 thousand in 2014.
- Balance-sheet-based aggregate accruals
- Aggregate accruals remained modest during the 2011 and 2012 fiscal years, measuring US$ 100,100 thousand and US$ 115,700 thousand, respectively. A substantial increase is observed in 2013, where accruals surged to US$ 512,900 thousand. This upward trajectory reversed abruptly in 2014, with the figure falling to a negative US$ 20,300 thousand, indicating a shift where cash flows exceeded accrual-based accounting earnings.
- Balance-sheet-based accruals ratio
- The accruals ratio mirrors the volatility of the aggregate accruals. The ratio remained low and stable at 2.33% in 2011 and 2.63% in 2012. A sharp spike to 10.87% occurred in 2013, suggesting a significant divergence between reported earnings and cash flow, which may indicate a decrease in the quality of financial reporting for that period. By 2014, the ratio corrected to -0.41%, a reversal that typically suggests higher earnings quality as the reliance on non-cash accruals diminished.
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Cash-Flow-Statement-Based Accruals Ratio
Allergan Inc., cash flow statement computation of aggregate accruals
US$ in thousands
| Dec 31, 2014 | Dec 31, 2013 | Dec 31, 2012 | Dec 31, 2011 | Dec 31, 2010 | ||
|---|---|---|---|---|---|---|
| Net earnings attributable to Allergan, Inc. | 1,524,200) | 985,100) | 1,098,800) | 934,500) | 600) | |
| Less: Net cash provided by operating activities | 1,927,800) | 1,695,400) | 1,599,900) | 1,081,900) | 463,900) | |
| Less: Net cash (used in) provided by investing activities | 182,700) | (1,375,300) | (589,300) | 340,800) | (977,200) | |
| Cash-flow-statement-based aggregate accruals | (586,300) | 665,000) | 88,200) | (488,200) | 513,900) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | -11.81% | 14.10% | 2.00% | -11.36% | — | |
| 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: 2014-12-31), 10-K (reporting date: 2013-12-31), 10-K (reporting date: 2012-12-31), 10-K (reporting date: 2011-12-31), 10-K (reporting date: 2010-12-31).
1 2014 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × -586,300 ÷ [(4,954,000 + 4,974,300) ÷ 2] = -11.81%
2 Click competitor name to see calculations.
An analysis of the financial reporting quality from 2011 to 2014 reveals significant volatility in the relationship between reported earnings and actual cash flows. While the base of net operating assets remained relatively stable with a gradual increase, the aggregate accruals and the resulting accruals ratio exhibited sharp fluctuations, indicating inconsistent earnings quality over the four-year period.
- Net Operating Assets Trend
- Net operating assets demonstrated a general upward trend, rising from US$ 4,345,700 thousand in 2011 to a peak of US$ 4,974,300 thousand in 2013, before experiencing a slight contraction to US$ 4,954,000 thousand in 2014. This represents a relatively steady expansion of the operational asset base.
- Aggregate Accruals Volatility
- Cash-flow-statement-based aggregate accruals showed extreme variance. The figures transitioned from a negative US$ -488,200 thousand in 2011 to a positive US$ 88,200 thousand in 2012, peaking at US$ 665,000 thousand in 2013. This trend reversed sharply in 2014, with accruals falling to US$ -586,300 thousand.
- Accruals Ratio Interpretation
- The accruals ratio fluctuated significantly, moving from -11.36% in 2011 to 2.00% in 2012, and reaching a high of 14.10% in 2013, before dropping to -11.81% in 2014. The positive peak in 2013 indicates a period where reported accrual-based earnings significantly exceeded cash flows from operations. Conversely, the negative ratios in 2011 and 2014 suggest periods where cash flows were higher than reported accounting earnings, reflecting a high degree of variability in the timing of revenue and expense recognition relative to cash movements.
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