Firm Life Cycle, Accrual Characteristics And Accounting Conservatism

This paper examines how accruals affect the accounting conservatism in each firm life cycle stage. The data of all firm-years from CSMAR during the year 1998 to 2005 is as the evidence collected to support my studies.Evidence reveals that for Chinese listed companies, the firm characteristics in each stage of life cycle, such as profitability, investment expenses and other financial ratios typically follow a systematic variation. Firm-specific life cycle and industry life cycle are different, and a simple industry control variable fails to capture the distinct economic differences during each firm life cycle stage. Evolving process of the firm life cycle is not determined by the sequential manner. Its path is less predictable from these origin states. In the shakeout and decline stage, there are higher frequencies of delisting warnings in Chinese stock market. In the mutual fund practice, investment strategies adopted by growth style fund have similarities with the classification of the life cycle stage. The research results show that proxy based on a combination pattern of firm's cash flows can accurately classify different stages of Chinese listed firms, and has a parsimonious practicality characteristic, which can be employed in large-sample analysis.The paper results show that in China accruals evolve in direct response to managers' real operating decisions and business outcome. Firm life cycle, resulted from business strategies, competition environment, and the enterprise operations, are likely to have an important effect on firm's accruals determination. Previous accruals research did not recognize any source of accruals variation. Taking the changes of business fundamentals and the applicable accounting principles that can affect accruals for example, both of them lead to normal fluctuation of accruals, but neither are the result of opportunistic earnings management. Accruals properties are far more adequate and complex than those reflected by current empirical models. Adding life cycle into current accruals model can considerably improve the specification and power.The evidence also shows that for the Chinese listed companies, the accruals present systematic variation with firm life cycle. The difference of accounting conservatism, affected by the fundamentals, also displays systematic characteristic varying over the firm life cycle. It suggests that in the early stage, accrual is mostly positive and much more affluent in the quantity. Its primary role is to match and defer the recognition of revenue, as such, accrual smoothes the earnings. While the unconditional conservatism is strong, the conditional conservatism is weak, that is, unconditional conservatism preempts the conditional conservatism. In contrast, at the end of life cycle, accrual is negative, and the role is to accelerate the process for timely loss recognition. As such, the conditional conservatism is strong, whereas the unconditional is weak, and conditional conservatism preempts the unconditional conservatism. Therefore, generally speaking, the total conservatism shows a U shape with life cycle of a firm.The evidences also suggest the two types of accounting conservatism are substitutional. Firms in the introduction and growth stage could choose to be more unconditionally conservative to reduce the likelihood of conditional conservatism and so smooth income. On the contrary, firms in the decline and shakeout stage firms could adopt conditional conservatism to mute the growth-dependent biases caused by unconditional conservatism in the future periods.During the difference stages of the firms, the accruals have two different roles, that is, to smooth the income and to recognize loss timely. It is those distinct roles that lead to accruals' normal variation with the stages of firms. Essentially, the variation is not caused by management opportunities; rather, it is shaped partly because of the fundamentals links between accrual accounting and underlying economics. Current accounting standards, which dictate the measurement of earnings, reflect a mix of matching and fair value perspectives.