Intangible Investments and the Accrual-Cash Flow Relationship

Abstract

This paper investigates whether the weakening negative relationship between accruals and operating cash flows can be attributed to the immediate expensing of intangible investments under current accounting standards. Building on the framework proposed by Green et al. (2022), I examine how the mechanical capitalization of intangible investments affects the accrual-cash flow relationship across firms with varying R&D intensities. I show that the capitalization impacts the relationship in unexpected ways, indicating that the proposed rationale cannot fully explain the observed trend. I further exploit differences in accounting treatments under IFRS and US GAAP to test whether increased capitalization of intangible investments through development costs strengthens the relationship. I find that the relationship is significantly more negative under IFRS than US GAAP, independently of R&D expenditure, suggesting that increased capitalization alone does not explain the differences. Additionally, the positive trend observed for high R&D firms in both standards highlights that increased capitalization is insufficient to reverse the weakening trend. These results challenge the view that current accounting practices are the primary cause of the weakening accrual-cash flow relationship and underscore the need for further exploration of alternative explanations.