Accounting Conservatism and the Anticipation of Future Cash Flows

• In Event: Financial Accounting & Reporting 1
  In Paper Session: Financial Accounting & Reporting I

Abstract

I propose a classification system that defines accounting conservatism on the basis of the timing of cash flow realization rather than on the basis of news dependence (i.e., conditional versus unconditional conservatism). This classification method differentiates conservatism on the basis of whether it pertains to the anticipation of future cash flows in current earnings (future-cash-flow conservatism) or the allocation of prior cash flows into current earnings (prior-cash-flow conservatism). I specifically focus on future-cash-flow conservatism, as it is theoretically consistent with some prominent definitions of accounting conservatism. Additionally, I introduce an empirical measure of future-cash-flow conservatism that captures how conservatively firms anticipate future cash flows. I find that the future-cash-flow conservatism measure is persistent over accounting periods, consistent with the multi-period aspect of conservatism, and negatively associated with the book-to-market ratio, consistent with conservatism resulting in unrecorded economic value.

Author

• George Wesley Ruch, The University of Alabama