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
Illinois Tool Works Inc., balance sheet computation of aggregate accruals
US$ in millions
| Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | Dec 31, 2017 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 16,077) | 15,612) | 15,068) | 14,870) | 16,780) | |
| Less: Cash and equivalents | 1,527) | 2,564) | 1,981) | 1,504) | 3,094) | |
| Operating assets | 14,550) | 13,048) | 13,087) | 13,366) | 13,686) | |
| Operating Liabilities | ||||||
| Total liabilities | 12,451) | 12,430) | 12,038) | 11,612) | 12,191) | |
| Less: Short-term debt | 778) | 350) | 4) | 1,351) | 850) | |
| Less: Long-term debt | 6,909) | 7,772) | 7,754) | 6,029) | 7,478) | |
| Operating liabilities | 4,764) | 4,308) | 4,280) | 4,232) | 3,863) | |
| Net operating assets1 | 9,786) | 8,740) | 8,807) | 9,134) | 9,823) | |
| Balance-sheet-based aggregate accruals2 | 1,046) | (67) | (327) | (689) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 11.29% | -0.76% | -3.65% | -7.27% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Boeing Co. | 30.23% | — | — | — | — | |
| Caterpillar Inc. | 4.22% | — | — | — | — | |
| Eaton Corp. plc | 10.92% | — | — | — | — | |
| GE Aerospace | -33.29% | — | — | — | — | |
| Honeywell International Inc. | 9.04% | — | — | — | — | |
| Lockheed Martin Corp. | 23.38% | — | — | — | — | |
| RTX Corp. | 1.48% | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Sector | ||||||
| Capital Goods | -0.06% | 200.00% | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | ||||||
| Industrials | 3.43% | 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
= 14,550 – 4,764 = 9,786
2 2021 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2021 – Net operating assets2020
= 9,786 – 8,740 = 1,046
3 2021 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 1,046 ÷ [(9,786 + 8,740) ÷ 2] = 11.29%
4 Click competitor name to see calculations.
- Net Operating Assets
- The net operating assets exhibited a slight decline from 9,134 million US dollars at the end of 2018 to 8,807 million in 2019, followed by a further marginal decrease to 8,740 million in 2020. However, there was a notable increase in 2021, with net operating assets rising to 9,786 million, surpassing the 2018 level. This trend indicates a period of contraction in net operating assets during the first three years, succeeded by expansion in the latest year reported.
- Balance-sheet-based Aggregate Accruals
- The balance-sheet-based aggregate accruals showed a consistent trend of moving towards less negative values from 2018 to 2020, rising from -689 million US dollars in 2018 to -327 million in 2019 and subsequently to -67 million in 2020. This trajectory reversed sharply in 2021, with aggregate accruals becoming positive at 1,046 million. The shift from negative to positive accruals in the final year suggests a significant change in accrual dynamics or accounting practices impacting earnings quality.
- Balance-sheet-based Accruals Ratio
- The accruals ratio followed a similar pattern to the aggregate accruals, starting at -7.27% in 2018 and improving steadily to -3.65% in 2019 and -0.76% in 2020. In 2021, the ratio transitioned abruptly to a positive 11.29%. This substantial increase into positive territory aligns with the sharp rise in aggregate accruals and may indicate increased earnings management or changes in the underlying economic conditions affecting accrual-based earnings quality.
Cash-Flow-Statement-Based Accruals Ratio
Illinois Tool Works Inc., cash flow statement computation of aggregate accruals
US$ in millions
| Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | Dec 31, 2017 | ||
|---|---|---|---|---|---|---|
| Net income | 2,694) | 2,109) | 2,521) | 2,563) | 1,687) | |
| Less: Net cash provided by operating activities | 2,557) | 2,807) | 2,995) | 2,811) | 2,402) | |
| Less: Net cash used for investing activities | (984) | (214) | (183) | (325) | (251) | |
| Cash-flow-statement-based aggregate accruals | 1,121) | (484) | (291) | 77) | (464) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | 12.10% | -5.52% | -3.24% | 0.81% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Boeing Co. | -43.09% | — | — | — | — | |
| Caterpillar Inc. | 5.38% | — | — | — | — | |
| Eaton Corp. plc | 7.52% | — | — | — | — | |
| GE Aerospace | -53.22% | — | — | — | — | |
| Honeywell International Inc. | 2.16% | — | — | — | — | |
| Lockheed Martin Corp. | -10.24% | — | — | — | — | |
| RTX Corp. | -1.96% | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Sector | ||||||
| Capital Goods | -13.86% | -3.12% | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | ||||||
| Industrials | -8.91% | -5.18% | — | — | — | |
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 × 1,121 ÷ [(9,786 + 8,740) ÷ 2] = 12.10%
2 Click competitor name to see calculations.
- Net Operating Assets
- The net operating assets decreased slightly from 9,134 million US dollars in 2018 to 8,807 million in 2019 and further down to 8,740 million in 2020, indicating a gradual contraction in the company's operating asset base over these two years. However, in 2021, there was a rebound to 9,786 million US dollars, surpassing the 2018 value and suggesting a renewed investment or growth phase in operating assets.
- Cash-flow-statement-based Aggregate Accruals
- Aggregate accruals exhibited notable volatility across the four years. In 2018, the figure was a positive 77 million US dollars, which then sharply declined to negative values in 2019 and 2020, at -291 million and -484 million respectively. This trend shows increased use of accruals or adjustments that reduce reported earnings relative to cash flow. In 2021, the figure flipped substantially to a positive 1,121 million US dollars, reflecting a significant reversal or adjustment in accrual accounting practices or operational cash flow timing.
- Cash-flow-statement-based Accruals Ratio
- The accruals ratio presents a corresponding pattern of fluctuation, starting at 0.81% in 2018, shifting to negative territory at -3.24% in 2019, and further declining to -5.52% in 2020. These negative ratios indicate that accruals detracted from cash flow conversion in those periods. The ratio then sharply increased to 12.1% in 2021, representing a large positive effect of accruals relative to cash flow, which suggests a significant change in the quality or recognition timing of earnings relative to cash inflows.