We know that: Aggregate accruals = Accrual based earnings – Cash earnings Let’s say we have 2013 Cash = 10 Common stock = 10 Liabilities = 0 Earnings = 0 2014 Cash = 0 PPE = 10 Liabilities = 0 Common stock = 10 Earnings = 0 NOA = [Total assets−Cash)−(Total liabilities−Total debt)] NOA_2013 = 10 - 10 = 0 NOA_2014 = 10 - 0 = 10 Aggregate accruals = 10 Cash earnings = 0 Accrual-based earnings = 0 (since earnings are 0) Something is wrong!!!
I don’t think we use total assets here, I think we use operating assets, so it excludes PPE
No (and this is the other unusual thing) it says pag. 391 that:
Total assets - cash = OPERATING ASSETS
but SORRY … I find out!!!
CASH earnings in the above exaple is equal to 10
So I have:
Aggregate accruals = 10 Cash earnings = - 10 Accrual-based earnings = 0
and this makes sense!
However this part is poorly written and explained!
However there is a problem with financial debt…
Let’s say we have
2013
Income=0 Cash = 0 Financial Debt = 0 Earnings = 0
2014
Income=0 Cash = 0 PPE = 10 Financial Debt = 10 Earnings = 0 NOA = [Total assets−Cash)−(Total liabilities−Total debt)] NOA_2013 = 0 - 0 = 0 NOA_2014 = 10 - (10-10) = 10 Aggregate accruals = 10 Cash earnings = 0 Accrual-based earnings = 0
So we would have:
Aggregate accruals = Accrual based earnings – Cash earnings
10=0-0
???
well both the BS method and the IS method are explained differently here: http://www.investopedia.com/university/accounting-earnings-quality/earnings5.asp
and I agree much much more with this explanation!
This is another part completely poorly written…congratulations to the author!
Operating assets excludes non-operating assets and subtracts operating liabilities.
Using the definition of the CFA
Operating assets = Total assets - Cash
Net operating assets = Operating assets - (Total liabilities - Financial debt)
Investopedia’s derivation is helpful as it makes you realize the shortcuts taken by CFA.Btw you have a mistake in your NOA equation. It should be
Net Operating Assets =Operating assets - (Total liabilities - Financial debt)
If you expand Operating assets you get
Net Operating Assets=Total assets- Cash - Total liabilities + Financial debt
The first 3 terms are the Investopedia equation. The difference is that CFA adds Financial Debt, which is strange if the goal is to get to the change in non-cash assets that derives from the earnings. So we could perfectly consider a PP&E expenditure funded through debt as representing accrual-based earnings? Odd…
you are right, and I corrected it…