A review of accrual accounting and cash flow techniques for use in equity valuation

Abstract

Purpose

The purpose of this paper is to survey the accounting concepts of valuation and the direction of accounting research in terms of development of valuation models. It also simulates some of the models. Moreover, the Dividend Discount Model, a financial model, is the foundation of a number of accounting based models and is discussed.

Design/methodology/approach

The objectives are achieved by surveying the literature for accounting models and empirical evidence for the model. The methodology also incorporates simulating the models under different conditions to find out the valuation predicted.

Findings

It was found out that the accounting models predict that accrual principles play a role in increasing the discrepancy between the book value and the market value of equity. Some of the recent valuation models, like the Feltham–Ohlson linear information model, incorporate accrual principles like conservatism. Though the empirical evidences are mixed for these models, it provides a theoretical framework to incorporate accrual principles in the accounting valuation models.

Practical implications

This paper provides practitioners with a snapshot of different models and their limitations.

Originality/value

This paper provides a comprehensive picture of the state of accounting valuation models and provides input for further development of these models.

Citation

Faseruk, A. and Faseruk, A. (2008), "A review of accrual accounting and cash flow techniques for use in equity valuation", Management Research News, Vol. 31 No. 6, pp. 418-433. https://doi.org/10.1108/01409170810876026