On reading 26: Evaluating Financial reporting Quality, when measuring the accrual component of Earnings, it has a formula: Aggregate accruals= accrual-basis earning- cash earnings. and: Aggregate accruals = NOA ending - NOA opening (Net Operating Assets =[total assets-cash]-[total liabilities-total dept]) I just learn by heart this formula but do not understand the relationship between NOA and aggregate accruals. Why NOA ending-NOA opening = Aggregate accruals? Could you help me to demonstrate this formula? Thank so much!
Here is my understanding: You can get to aggregate accruals two ways, balance sheet or income statement. Income statement - first formula - accrual earnings less cash Balance sheet Method- Basically, you are looking to get the same number how much of your earnings were accrual vs cash. From the balance sheet its a little more confusing but remember how the income statement flows into the balance sheet. So you are looking for changes in operating assets and changes in operating liabilities that will tell you how much of the earnings was “accrual” accounting related. So if you collected less cash (extended riskier credit maybe?) then your sales increase but your operating assets increase because you didn’t get cash. So your aggregate accruals increased which indicated poorer earnings quality. Hope that helps and makes sense.