Comparing GAAP With NIPA Earnings

Abstract

The U.S. Bureau of Economic Analysis produces a measure of aggregate corporate profits (national income and product accounts [NIPA] earnings), which is an integral component of the accounting for gross domestic product (GDP). Interesting features of NIPA earnings include consistent accounting rules over time and determination with little or no managerial discretion. Thus, NIPA earnings provide a useful benchmark for generally accepted accounting principles (GAAP) earnings, especially in parsing out the effects of real-economy versus the accounting in explaining the documented temporal increase in volatility and decline in persistence of GAAP earnings. We find that GAAP and NIPA earnings are closely related in the early years, with similar means and standard deviations, and with earnings changes correlating at .90 during 1950-1983. This close relation substantially deteriorates, however, during the second half of the sample period, 1984-2016. Although the behavior of NIPA earnings remains roughly the same, the volatility of GAAP earnings increases 10-fold, and the correlation between GAAP and NIPA earnings changes falls to .39. Additional tests reveal that the increase in the volatility of GAAP earnings is mostly due to rapid earnings reversals, especially the effect of large transient items during economic downturns. The frequency and severity of such downturns, however, are roughly the same across the two periods. In addition, there is little change in the properties of aggregate cash flow from operations and revenue over time. Overall, this evidence suggests that in addition to changes in the real economy, changing GAAP rules and their application are significant factors in the changing properties of GAAP earnings.

On the Expected Earnings Hypothesis Explanation of the Aggregate Returns–Earnings Association Puzzle

“…The changed correlation can originate in changes in the properties of aggregate earnings. Dichev and Zhao (2018) find that aggregate earnings are recently more volatile and less correlated with the stable National Income and Product Accounts (NIPA) earnings. They suggest changes in GAAP rules as a possible cause.…”

“…Dichev and Zhao (2018) study annual 1950-2016 data divided into 2 equal subperiods. Interestingly, theirFigure 3shows a dramatic increase in earnings volatility starting in 2000 or 2001.26 The standard deviation increases from 0.0038 in 1970-2000 to 0.0075 in 2001-2017 Dichev and Zhao (2018). report that volatility of annual net income growth is 10 times higher in 1984-2016 than in 1950-1983.…”

Analysis on the Effects of Quality of Financial Statements, Over GDP Forecasting Models. An Empirical Cross-Country Approach

“…Seem that the compensation effect of aggregating firm accounting earnings does not eliminate their conservative component, meaning that accounting conservatism extend beyond firms' asymmetric timeliness on earnings reporting. Additionally, Dichev & Zhao (2019) have underlined a significant correlation between NIPA component of GDP and the economic growth. On those circumstances, it is essential to evaluate the impact of accounting earnings asymmetric timeliness on macroeconomic estimates.…”

“…Quality of firms' disclosed financial statements determine indirect effects on GDP, through NIPA component (Dichev & Zhao, 2019). As outlined by Bruggemann et.…”

“…Additional to these sources, studies such as Konchichki & Patatoukas (2014), Lechien (2017) or Fargher & Zhang (2020), emphasize the role of accounting earnings on explaining economic growth estimates, or even the accuracy of those estimates. As noted by Dichev & Zhao (2019), macroeconomic estimates are highly correlated with firms' accounting earnings, especially through GDP component of NIPA. Consequently, the quality of reported accounting earnings affects indirectly GDP growth estimates.…”