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Accounting Conservatism and the Temporal Trends in Current Earnings’ Ability to Predict Future Cash Flows versus Future Earnings: Evidence on the Trade†off between Relevance and Reliability

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  • SATI P. BANDYOPADHYAY
  • CHANGLING CHEN
  • ALAN G. HUANG
  • RANJINI JHA

Abstract

This research reports that an increasing level of accounting conservatism over the 1973–2005 period is associated with: (1) an increase in the ability of current earnings to predict future cash flows and (2) a decrease in the ability of current earnings to predict future earnings. We also find that usefulness of earnings for explaining stock prices over book values is positively related to reliability but not to relevance. Our results hold for the constant and full samples in both in†sample and out†of†sample analyses and are robust to the use of alternative measures for relevance, reliability, earnings usefulness, and conservatism. Our findings about the relations among conservatism, relevance, reliability, and usefulness suggest a trade†off between relevance and reliability and seem to indicate that the adoption of an increasing number of conservative accounting standards has a possible adverse impact on earnings usefulness through a negative effect on reliability.

Suggested Citation

  • Sati P. Bandyopadhyay & Changling Chen & Alan G. Huang & Ranjini Jha, 2010. "Accounting Conservatism and the Temporal Trends in Current Earnings’ Ability to Predict Future Cash Flows versus Future Earnings: Evidence on the Trade†off between Relevance and Reliability," Contemporary Accounting Research, John Wiley & Sons, vol. 27(2), pages 344-344, June.
    • Handle: RePEc:wly:coacre:v:27:y:2010:i:2:p:344-344
    DOI: 10.1111/j.1911-3846.2010.01023_2.x
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    Cited by:

    1. Oz, Ibrahim Onur & Yelkenci, Tezer & Meral, Gorkem, 2021. "The role of earnings components and machine learning on the revelation of deteriorating firm performance," International Review of Financial Analysis, Elsevier, vol. 77(C).
    2. Krishnan, Gopal V. & Zhang, Jing, 2022. "Principles-based standards and conditional accounting conservatism," Advances in accounting, Elsevier, vol. 58(C).
    3. Shadi Farshadfar & Reza M. Monem, 2019. "Further evidence of the relationship between accruals and future cash flows," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 59(1), pages 143-176, March.
    4. Xingxing Hu & Xiaobao Song & Wunhong Su, 2023. "Ill‐intentioned or well‐intentioned: earnings management and trade credit," Asian-Pacific Economic Literature, The Crawford School, The Australian National University, vol. 37(1), pages 88-120, May.
    5. Libor Závodný, 2021. "Relevance versus Reliability Trade-off in Financial Reporting among Companies Listed at Visegrad Group Stock Exchanges," European Financial and Accounting Journal, Prague University of Economics and Business, vol. 2021(1), pages 7-24.
    6. Shadi Farshadfar & Reza Monem, 2013. "The usefulness of operating cash flow and accrual components in improving the predictive ability of earnings: a re-examination and extension," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(4), pages 1061-1082, December.
    7. Farshadfar, Shadi & Samarbakhsh, Laleh & Jiang, Yige, 2023. "Financial statement comparability and the usefulness of earnings: Some Canadian evidence," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 52(C).
    8. Moy, Melissa & Heaney, Richard & Tarca, Ann & van Zyl, Warrick, 2020. "Conditional accounting conservatism: Exploring the impact of changes in institutional frameworks in four countries," Journal of Contemporary Accounting and Economics, Elsevier, vol. 16(3).

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