Abstract The objective of this exercise is to illustrate some inherent benefits of accrual accounting. The assignment examines the smoothing and aggregation properties of accrual income and shows how these properties relate accrual income to cash flows and market returns. Students are provided with time-series data for Kmart Corporation from 1937 to 1991 to compare the characteristics of accrual income, operating cash flow and market returns, and to understand how these variables relate to each other. The exercise helps demonstrate that accrual income has lower variance, higher correlation with returns and higher predictive ability for returns than cash flow from operations. The analysis also highlights the aggregation property—over long time periods, aggregate accrual income, cash flow and returns capture the same total information.
Pervin K. Shroff (Sun,) studied this question.