Chapter

Value-Based Management and Performance Measures: Cash Flow versus Accrual Accounting

Dieter Pfaff

in The Economics and Politics of Accounting

Published in print March 2004 | ISBN: 9780199260621
Published online January 2005 | e-ISBN: 9780191601668 | DOI: http://dx.doi.org/10.1093/0199260621.003.0004
 Value-Based Management and Performance Measures: Cash Flow versus Accrual Accounting

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The objective is to reflect on the merits of accrual accounting in light of its various imperfections, and to provide some explanation for why we still have only a limited understanding of accruals. The argument presented is based on a two-period model and attempts to demonstrate the problem of the ‘impatient manager’ to show how accruals can help solve this problem. The goal is to lay out the basic rationalization for using both accruals and the underlying assumptions and relationships as clearly and simply as possible. This rationale is then used as the basis for an examination of the question of which direction we might use to develop new models that propose the advantages of using accruals. The chapter is organized as follows: Section 1 introduces; Section 2 shows the substantial assumptions for the analysis of accruals – and cash-flow-based incentive systems in investment decisions; Section 3 discusses accruals as optimal performance measures, clarifying the connections between compensation functions and performance measures, and showing how performance measures can be designed to induce efficient investment decisions in a two-period model; Section 4 summarizes the results, thereby taking a more general look at the connections between incentive contracts, performance measures, and information structures; Section 5 discusses the problems of analytical research in showing the advantage of using accruals instead of cash flows as a performance measure to control investment decisions; Section 6 concludes.

Keywords: accounting; accrual accounting; accruals; analytical research; cash flows; compensation functions; incentive contracts; information structures; investment decisions; performance measures; two-period model

Chapter.  9776 words. 

Subjects: Financial Markets

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