Discretionary Accruals and the Emergence of Profitability

We examine discretionary accruals associated with firms' reaching profitability after a series of quarterly losses. We posit that as firms approach profitability they are less likely to use income decreasing discretion given the reversing nature of accruals. We find results consistent with this behavior. We document that the discretionary accrual behavior for firms that remain profitable contrasts to that of a control sample that does not remain profitable. In the quarters preceding a reported profit, firms that sustain profitability use significantly lower income increasing discretionary accruals. For these firms we also find that past discretion relates inversely to future profitability. We interpret our results as evidence of conditional discretionary accrual behavior centered on break-even net income.