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
Baxter International Inc., balance sheet computation of aggregate accruals
US$ in millions
| Dec 31, 2015 | Dec 31, 2014 | Dec 31, 2013 | Dec 31, 2012 | Dec 31, 2011 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 20,975) | 25,917) | 25,869) | 20,390) | 19,073) | |
| Less: Cash and equivalents | 2,213) | 2,925) | 2,733) | 3,270) | 2,905) | |
| Less: Investment in Baxalta common stock | 5,148) | —) | —) | —) | —) | |
| Operating assets | 13,614) | 22,992) | 23,136) | 17,120) | 16,168) | |
| Operating Liabilities | ||||||
| Total liabilities | 12,110) | 17,761) | 17,383) | 13,412) | 12,245) | |
| Less: Short-term debt | 1,775) | 913) | 181) | 27) | 256) | |
| Less: Current maturities of long-term debt and lease obligations | 810) | 786) | 859) | 323) | 190) | |
| Less: Long-term debt and lease obligations, excluding current maturities | 3,935) | 7,606) | 8,126) | 5,580) | 4,749) | |
| Operating liabilities | 5,590) | 8,456) | 8,217) | 7,482) | 7,050) | |
| Net operating assets1 | 8,024) | 14,536) | 14,919) | 9,638) | 9,118) | |
| Balance-sheet-based aggregate accruals2 | (6,512) | (383) | 5,281) | 520) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | -57.73% | -2.60% | 43.01% | 5.54% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Abbott Laboratories | — | — | — | — | — | |
| Elevance Health Inc. | — | — | — | — | — | |
| Intuitive Surgical Inc. | — | — | — | — | — | |
| Medtronic PLC | — | — | — | — | — | |
| UnitedHealth Group Inc. | — | — | — | — | — | |
Based on: 10-K (reporting date: 2015-12-31), 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).
1 2015 Calculation
Net operating assets = Operating assets – Operating liabilities
= 13,614 – 5,590 = 8,024
2 2015 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2015 – Net operating assets2014
= 8,024 – 14,536 = -6,512
3 2015 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × -6,512 ÷ [(8,024 + 14,536) ÷ 2] = -57.73%
4 Click competitor name to see calculations.
The financial reporting quality between 2012 and 2015 is characterized by extreme volatility in both the magnitude and direction of accruals. A significant shift is observed from high positive accruals in the early part of the period to deeply negative accruals by 2015, suggesting substantial changes in the relationship between reported earnings and cash flows.
- Net Operating Assets
- Net operating assets experienced a sharp increase from US$ 9,638 million in 2012 to a peak of US$ 14,919 million in 2013. This level remained relatively stable through 2014 at US$ 14,536 million before undergoing a substantial contraction to US$ 8,024 million by the end of 2015, representing a nearly 45% decrease from the 2014 levels.
- Balance-Sheet-Based Aggregate Accruals
- Aggregate accruals demonstrated a dramatic reversal over the four-year period. After starting at US$ 520 million in 2012, accruals surged to US$ 5,281 million in 2013. This positive trend inverted sharply in 2014, moving into negative territory at -US$ 383 million, and culminated in a deep decline to -US$ 6,512 million in 2015. This trajectory indicates a transition from a period where earnings significantly exceeded cash flow to a period where cash flow significantly exceeded reported earnings.
- Balance-Sheet-Based Accruals Ratio
- The accruals ratio mirrors the volatility of the aggregate accruals, fluctuating from 5.54% in 2012 to a high of 43.01% in 2013. The subsequent drop to -2.60% in 2014 and a further plunge to -57.73% in 2015 indicates a severe shift in reporting quality metrics. The high positive ratio in 2013 may suggest aggressive accrual accounting or significant non-cash gains, while the deeply negative ratio in 2015 typically suggests significant non-cash charges, asset write-downs, or a conservative shift in reporting.
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Cash-Flow-Statement-Based Accruals Ratio
Baxter International Inc., cash flow statement computation of aggregate accruals
US$ in millions
| Dec 31, 2015 | Dec 31, 2014 | Dec 31, 2013 | Dec 31, 2012 | Dec 31, 2011 | ||
|---|---|---|---|---|---|---|
| Net income attributable to Baxter | 968) | 2,497) | 2,012) | 2,326) | 2,224) | |
| Less: Cash flows from operations | 1,129) | 3,215) | 3,198) | 3,106) | 2,817) | |
| Less: Cash flows from investing activities | (861) | (1,542) | (5,362) | (1,569) | (1,427) | |
| Cash-flow-statement-based aggregate accruals | 700) | 824) | 4,176) | 789) | 834) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | 6.21% | 5.59% | 34.01% | 8.41% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Abbott Laboratories | — | — | — | — | — | |
| Elevance Health Inc. | — | — | — | — | — | |
| Intuitive Surgical Inc. | — | — | — | — | — | |
| Medtronic PLC | — | — | — | — | — | |
| UnitedHealth Group Inc. | — | — | — | — | — | |
Based on: 10-K (reporting date: 2015-12-31), 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).
1 2015 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × 700 ÷ [(8,024 + 14,536) ÷ 2] = 6.21%
2 Click competitor name to see calculations.
The financial reporting quality between 2012 and 2015 is characterized by a period of significant volatility, primarily concentrated in the 2013 fiscal year, followed by a period of relative stabilization and a contraction in the asset base.
- Net Operating Assets
- A substantial increase in net operating assets occurred between 2012 and 2013, rising from 9,638 million US$ to 14,919 million US$. This level remained relatively stable through 2014 at 14,536 million US$, before experiencing a sharp decline to 8,024 million US$ by the end of 2015. This trajectory indicates a significant restructuring or divestment of operating assets in the final year of the period.
- Cash-flow-statement-based Aggregate Accruals
- Aggregate accruals exhibited a dramatic spike in 2013, reaching 4,176 million US$, compared to 789 million US$ in 2012. This represents a significant divergence between accrual-based accounting earnings and actual cash flow for that period. Following this peak, accruals reverted to lower levels, recording 824 million US$ in 2014 and 700 million US$ in 2015.
- Cash-flow-statement-based Accruals Ratio
- The accruals ratio serves as a proxy for earnings quality, where lower ratios typically suggest higher quality earnings. The ratio rose sharply from 8.41% in 2012 to a peak of 34.01% in 2013, suggesting a temporary decrease in reporting quality or the impact of significant non-cash accounting adjustments. Subsequently, the ratio declined to 5.59% in 2014 and remained stable at 6.21% in 2015, indicating that earnings became more closely aligned with cash flows in the latter part of the observed period.
In summary, while 2013 presented a notable anomaly in both aggregate accruals and the resulting ratio, the subsequent two years demonstrate a return to a more conservative accrual profile, coinciding with a significant reduction in the company's net operating asset base.
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