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
Carrier Global Corp., balance sheet computation of aggregate accruals
US$ in millions
| Dec 31, 2022 | Dec 31, 2021 | Dec 31, 2020 | ||
|---|---|---|---|---|
| Operating Assets | ||||
| Total assets | 26,086) | 26,172) | 25,093) | |
| Less: Cash and cash equivalents | 3,520) | 2,987) | 3,115) | |
| Operating assets | 22,566) | 23,185) | 21,978) | |
| Operating Liabilities | ||||
| Total liabilities | 18,010) | 19,078) | 18,515) | |
| Less: Current portion of long-term debt | 140) | 183) | 191) | |
| Less: Long-term debt, net of current portion | 8,702) | 9,513) | 10,036) | |
| Operating liabilities | 9,168) | 9,382) | 8,288) | |
| Net operating assets1 | 13,398) | 13,803) | 13,690) | |
| Balance-sheet-based aggregate accruals2 | (405) | 113) | —) | |
| Financial Ratio | ||||
| Balance-sheet-based accruals ratio3 | -2.98% | 0.82% | — | |
| Benchmarks | ||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||
| Boeing Co. | -12.09% | — | — | |
| Caterpillar Inc. | 1.82% | — | — | |
| Eaton Corp. plc | 2.87% | — | — | |
| GE Aerospace | -7.82% | — | — | |
| Honeywell International Inc. | -1.99% | — | — | |
| Lockheed Martin Corp. | 15.67% | — | — | |
| RTX Corp. | 1.57% | — | — | |
| Balance-Sheet-Based Accruals Ratio, Sector | ||||
| Capital Goods | -0.33% | 200.00% | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | ||||
| Industrials | 0.67% | 200.00% | — | |
Based on: 10-K (reporting date: 2022-12-31), 10-K (reporting date: 2021-12-31), 10-K (reporting date: 2020-12-31).
1 2022 Calculation
Net operating assets = Operating assets – Operating liabilities
= 22,566 – 9,168 = 13,398
2 2022 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2022 – Net operating assets2021
= 13,398 – 13,803 = -405
3 2022 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × -405 ÷ [(13,398 + 13,803) ÷ 2] = -2.98%
4 Click competitor name to see calculations.
An analysis of the balance-sheet-based accruals reveals a significant shift in the quality of financial reporting between fiscal year 2021 and 2022. While the underlying asset base remained relatively stable, the aggregate accruals transitioned from a positive to a negative position, indicating a change in the relationship between reported earnings and cash flows.
- Net Operating Assets
- Net operating assets experienced a slight contraction, decreasing from 13,803 million US dollars in 2021 to 13,398 million US dollars in 2022. This represents a marginal decline of approximately 2.9%, suggesting a consistent scale of operations over the two-year period.
- Balance-sheet-based Aggregate Accruals
- A substantial reversal is observed in aggregate accruals, which fell from 113 million US dollars in 2021 to negative 405 million US dollars in 2022. This swing indicates that the components of the balance sheet shifted from supporting accrual-based earnings to a state where cash flows likely exceeded reported accounting profits.
- Balance-sheet-based Accruals Ratio
- The accruals ratio reflects this volatility, moving from 0.82% in 2021 to negative 2.98% in 2022. From a financial reporting quality perspective, the transition to a negative ratio suggests a move toward more conservative earnings reporting, as negative accruals typically imply that earnings are backed by strong cash flow generation rather than accounting adjustments.
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Cash-Flow-Statement-Based Accruals Ratio
Carrier Global Corp., cash flow statement computation of aggregate accruals
US$ in millions
| Dec 31, 2022 | Dec 31, 2021 | Dec 31, 2020 | ||
|---|---|---|---|---|
| Net income attributable to common shareowners | 3,534) | 1,664) | 1,982) | |
| Less: Net cash flows provided by operating activities | 1,743) | 2,237) | 1,692) | |
| Less: Net cash flows (used in) provided by investing activities | 1,745) | (692) | 1,106) | |
| Cash-flow-statement-based aggregate accruals | 46) | 119) | (816) | |
| Financial Ratio | ||||
| Cash-flow-statement-based accruals ratio1 | 0.34% | 0.87% | — | |
| Benchmarks | ||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||
| Boeing Co. | -50.32% | — | — | |
| Caterpillar Inc. | 3.26% | — | — | |
| Eaton Corp. plc | 4.55% | — | — | |
| GE Aerospace | -15.92% | — | — | |
| Honeywell International Inc. | -0.79% | — | — | |
| Lockheed Martin Corp. | -1.36% | — | — | |
| RTX Corp. | 0.87% | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Sector | ||||
| Capital Goods | -5.98% | -27.73% | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | ||||
| Industrials | -2.30% | -17.51% | — | |
Based on: 10-K (reporting date: 2022-12-31), 10-K (reporting date: 2021-12-31), 10-K (reporting date: 2020-12-31).
1 2022 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × 46 ÷ [(13,398 + 13,803) ÷ 2] = 0.34%
2 Click competitor name to see calculations.
An analysis of the financial reporting quality indicates a significant reduction in the reliance on non-cash accruals between the 2021 and 2022 fiscal years. The cash-flow-statement-based accruals ratio experienced a notable decline, falling from 0.87% on December 31, 2021, to 0.34% on December 31, 2022. This downward trend suggests an improvement in earnings quality, as a greater proportion of reported earnings is supported by actual cash flows.
- Net Operating Assets
- Net operating assets decreased slightly from 13,803 million US dollars to 13,398 million US dollars. This modest contraction indicates a stable asset base, ensuring that the observed changes in the accruals ratio are not primarily driven by significant fluctuations in the denominator of the calculation.
- Cash-flow-statement-based Aggregate Accruals
- Aggregate accruals saw a substantial decrease, dropping from 119 million US dollars in 2021 to 46 million US dollars in 2022. This represents a reduction of approximately 61%, signaling that the gap between accrual-based accounting income and cash flow from operations has narrowed considerably.
- Accruals Ratio Interpretation
- The compression of the accruals ratio to 0.34% reflects a high degree of convergence between reported profits and cash generation. This trend is typically interpreted as a positive indicator of financial reporting quality, as it minimizes the potential for earnings manipulation or the overstatement of performance through non-cash accounting entries.
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