Comparing the Quality of Accruals for Alternative Summary Performance Measures in the Real Estate Investment Trust (REIT) Industry

59 Pages Posted: 13 Sep 2006

See all articles by Desmond Tsang

Desmond Tsang

McGill University - Desautels Faculty of Management

Date Written: September 2006

Abstract

This study examines Funds from Operations (FFO), a non-GAAP summary performance measure used extensively by the Real Estate Investment Trust (REIT) industry, by comparing the quality of accruals in FFO and in net income. Accrual quality is empirically evaluated from regressions relating accruals to past, present, future cash flows and changes in revenue, with larger residuals implying lower accrual quality. Results show that the accruals component of FFO is of higher quality than the accruals component of net income. The study then considers how the individual accrual items excluded from FFO, but included in net income contribute to the accrual quality differences of the two measures. I show that all these accrual items (including depreciation and some non-recurring accruals) are of low quality and are insignificant in predicting future cash flows. Since accounting depreciation is supposed to help match revenue with expenses, it is surprising to find that depreciation accruals are of low quality for the REIT industry. Further analysis on depreciation shows that the low quality of depreciation accruals for REIT firms is due to estimation errors and managerial manipulation and, to some extent, extreme changes in market inflation.

Keywords: accounting quality, earnings management, real estate investment trust, accounting depreciation

JEL Classification: G30, G31, G35

Suggested Citation

Tsang, Desmond, Comparing the Quality of Accruals for Alternative Summary Performance Measures in the Real Estate Investment Trust (REIT) Industry (September 2006). AAA 2007 Financial Accounting & Reporting Section (FARS) Meeting Papers, Available at SSRN: https://ssrn.com/abstract=929540 or http://dx.doi.org/10.2139/ssrn.929540

Desmond Tsang (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

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