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
Edwards Lifesciences Corp., balance sheet computation of aggregate accruals
US$ in thousands
| Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | Dec 31, 2017 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 8,502,600) | 7,237,100) | 6,488,100) | 5,323,700) | 5,695,800) | |
| Less: Cash and cash equivalents | 862,800) | 1,183,200) | 1,179,100) | 714,100) | 818,300) | |
| Less: Short-term investments | 604,000) | 219,400) | 337,800) | 242,400) | 519,200) | |
| Operating assets | 7,035,800) | 5,834,500) | 4,971,200) | 4,367,200) | 4,358,300) | |
| Operating Liabilities | ||||||
| Total liabilities | 2,666,700) | 2,662,800) | 2,339,800) | 2,183,300) | 2,739,600) | |
| Less: Short-term debt | —) | —) | —) | —) | 598,000) | |
| Less: Long-term debt | 595,700) | 595,000) | 594,400) | 593,800) | 438,400) | |
| Operating liabilities | 2,071,000) | 2,067,800) | 1,745,400) | 1,589,500) | 1,703,200) | |
| Net operating assets1 | 4,964,800) | 3,766,700) | 3,225,800) | 2,777,700) | 2,655,100) | |
| Balance-sheet-based aggregate accruals2 | 1,198,100) | 540,900) | 448,100) | 122,600) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 27.44% | 15.47% | 14.93% | 4.51% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Abbott Laboratories | — | — | — | — | — | |
| Elevance Health Inc. | — | — | — | — | — | |
| Intuitive Surgical Inc. | — | — | — | — | — | |
| Medtronic PLC | — | — | — | — | — | |
| UnitedHealth Group Inc. | — | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Sector | ||||||
| Health Care Equipment & Services | 200.00% | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | ||||||
| Health Care | 200.00% | — | — | — | — | |
Based on: 10-K (reporting date: 2021-12-31), 10-K (reporting date: 2020-12-31), 10-K (reporting date: 2019-12-31), 10-K (reporting date: 2018-12-31), 10-K (reporting date: 2017-12-31).
1 2021 Calculation
Net operating assets = Operating assets – Operating liabilities
= 7,035,800 – 2,071,000 = 4,964,800
2 2021 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2021 – Net operating assets2020
= 4,964,800 – 3,766,700 = 1,198,100
3 2021 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 1,198,100 ÷ [(4,964,800 + 3,766,700) ÷ 2] = 27.44%
4 Click competitor name to see calculations.
A consistent upward trajectory is observed in both net operating assets and aggregate accruals over the four-year period from 2018 to 2021. While net operating assets grew steadily, the balance-sheet-based aggregate accruals increased at a significantly faster pace, leading to a substantial rise in the accruals ratio.
- Net Operating Assets
- Net operating assets experienced continuous growth, increasing from 2,777,700 thousand US dollars in 2018 to 4,964,800 thousand US dollars in 2021. This reflects a steady expansion of the operating asset base over the analyzed timeframe.
- Balance-Sheet-Based Aggregate Accruals
- Aggregate accruals exhibited an accelerated increase, rising from 122,600 thousand US dollars in 2018 to 1,198,100 thousand US dollars in 2021. A particularly sharp increase is noted between 2020 and 2021, where accruals grew by approximately 121% in a single fiscal year.
- Balance-Sheet-Based Accruals Ratio
- The accruals ratio climbed from 4.51% in 2018 to 27.44% in 2021. Following a significant jump between 2018 and 2019, the ratio remained relatively stable through 2020 at approximately 15% before surging to 27.44% in the final year.
The substantial escalation of the accruals ratio indicates that a growing proportion of the company's reported earnings is derived from non-cash accruals relative to the size of its operating assets. This trend suggests a widening divergence between accounting earnings and cash flow generation, which typically indicates a decrease in the quality of financial reporting and may suggest more aggressive accounting treatments or a buildup of non-cash assets that have not yet been converted to cash.
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Cash-Flow-Statement-Based Accruals Ratio
Edwards Lifesciences Corp., cash flow statement computation of aggregate accruals
US$ in thousands
| Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | Dec 31, 2017 | ||
|---|---|---|---|---|---|---|
| Net income | 1,503,100) | 823,400) | 1,046,900) | 722,200) | 583,600) | |
| Less: Net cash provided by operating activities | 1,732,100) | 1,054,300) | 1,179,400) | 926,800) | 1,000,700) | |
| Less: Net cash (used in) provided by investing activities | (1,722,500) | (531,100) | (595,800) | 76,700) | (647,200) | |
| Cash-flow-statement-based aggregate accruals | 1,493,500) | 300,200) | 463,300) | (281,300) | 230,100) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | 34.21% | 8.59% | 15.43% | -10.36% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Abbott Laboratories | — | — | — | — | — | |
| Elevance Health Inc. | — | — | — | — | — | |
| Intuitive Surgical Inc. | — | — | — | — | — | |
| Medtronic PLC | — | — | — | — | — | |
| UnitedHealth Group Inc. | — | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Sector | ||||||
| Health Care Equipment & Services | 11.34% | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | ||||||
| Health Care | 14.62% | — | — | — | — | |
Based on: 10-K (reporting date: 2021-12-31), 10-K (reporting date: 2020-12-31), 10-K (reporting date: 2019-12-31), 10-K (reporting date: 2018-12-31), 10-K (reporting date: 2017-12-31).
1 2021 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × 1,493,500 ÷ [(4,964,800 + 3,766,700) ÷ 2] = 34.21%
2 Click competitor name to see calculations.
An examination of financial reporting quality indicates a period of substantial expansion in net operating assets accompanied by significant volatility in aggregate accruals between 2018 and 2021.
- Net Operating Assets Trend
- Net operating assets demonstrated consistent and accelerated growth over the four-year period, increasing from US$ 2,777,700 thousand in 2018 to US$ 4,964,800 thousand in 2021. This steady upward trajectory reflects a continuous expansion of the operational asset base.
- Aggregate Accruals Performance
- Cash-flow-statement-based aggregate accruals exhibited considerable fluctuation. The figures moved from a negative position of US$ -281,300 thousand in 2018 to a positive US$ 463,300 thousand in 2019, followed by a slight decrease to US$ 300,200 thousand in 2020. A sharp increase occurred in 2021, with accruals reaching US$ 1,493,500 thousand, indicating a significant divergence between accrual accounting and cash flow generation in the final year.
- Accruals Ratio Interpretation
- The cash-flow-statement-based accruals ratio shifted from -10.36% in 2018 to 34.21% in 2021. While the ratio experienced a moderate dip to 8.59% in 2020, the subsequent surge to 34.21% in 2021 is notable. Such a substantial increase in the ratio suggests that a larger portion of reported earnings is comprised of non-cash accruals relative to the net operating asset base, which typically signals a potential decline in the quality of earnings or an increase in aggressive accounting estimates during that period.
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