A model for identification of accounting quality

The main purpose of this study is to develop and measure the notion of accounting quality, which is defined here as the degree accounting accruals contribute to the accurate measurement of the firm’s economic performance.

The research proposes a set of moment conditions to disentangle the three distinct variance components: the variance of true performance, the variance of performance measurement component in accruals and the variance of accounting error. The GMM estimation has been used to solve the moment conditions and estimate the variance components. The research employs a sample of annual data of 180 firms listed in Tehran Security Exchange spanning the year 2004-2017. 

The research findings show that, on average, the standard deviation of performance component in accruals exceeds the standard deviation of accounting error.

The result overall implies that, on average, the benefits of using accounting accruals exceed its costs. This is consistent with the role of auditing in reducing the noise of accounting earnings and the current demand for accounting accrual process.

The study proposes a new and flexible method for capturing and identifying the notion of accounting quality.