Accruals
Recognition of revenues earned or expenses incurred but not yet received or paid in cash.
On the exam, the classic item gives you a firm whose net income is rising while operating cash flow stagnates or falls and asks for the most likely interpretation — the answer hinges on recognizing that the accrual component of earnings is less persistent than the cash component, so earnings tend to mean-revert and future results disappoint. A second pattern asks you to compute aggregate accruals: the balance-sheet method is the change in net operating assets, while the cash-flow method is net income minus CFO minus CFI. The two usually correlate, but the cash-flow version is often viewed as cleaner because it sidesteps distortions from acquisitions, divestitures, and currency translation (CFA Level I presents both as valid).
The trap is conflating accruals with revenue or receivables. Revenue is a single income-statement line recognized when control transfers to the customer (IFRS 15 / ASC 606); receivables are one specific accrual; accruals are the whole gap between earnings and cash, spanning payables and deferred revenue too. Don’t assume high accruals always mean fraud — growth firms legitimately build working capital. Hook: accruals are “earnings on paper, not yet in the bank.”
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