The Accrual Anomaly: Accrual Originations, Accrual Reversals, and Resolution of Uncertainty*

Tatiana Fedyk, Zvi Singer, Theodore Sougiannis

Research output: Contribution to journalArticle

Abstract

We combine a fundamental property of accruals and a behavioral phenomenon to provide an explanation for the accrual anomaly. The fundamental property is accruals that originate must subsequently reverse. The behavioral phenomenon is individuals tend to underestimate the variance of noisy signals in various domains of decision making. We argue that originating accruals represents a noisier signal than reversing accruals because the uncertainty of whether originating accruals will eventually convert into cash is high, while there is no uncertainty regarding reversing accruals. If investors underestimate the variance of originating accruals but understand reversing accruals, then originating accruals will be mispriced while reversing accruals will not. To test this prediction, we first develop and empirically validate a novel method for ex ante detecting accrual originations and their reversals. Then we document that investors face increased uncertainty when accruals originate and decreased uncertainty when accruals reverse, and we provide evidence that only originating accruals are mispriced. We further demonstrate that our findings can be useful for improving the accrual-based trading strategy by ex ante detecting and removing accrual reversals from extreme accrual portfolios. Overall, we provide a behavioral explanation for the accrual anomaly that is consistent with the mispricing of originating accruals only.

Original languageEnglish (US)
Pages (from-to)885-916
Number of pages32
JournalContemporary Accounting Research
Volume37
Issue number2
DOIs
StatePublished - Jun 1 2020

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

Fingerprint Dive into the research topics of 'The Accrual Anomaly: Accrual Originations, Accrual Reversals, and Resolution of Uncertainty<sup>*</sup>'. Together they form a unique fingerprint.

  • Cite this