ABSTRACT

Purpose: The study aimed to examine whether the financial statements of the listed companies at the Colombo Stock Exchange are value-relevant and what impact they have on stock price returns.

Methodology: A model based on red flag ratios that have been proven to be possible fraud indicators of falsified financial statements in various contexts was developed and employed. Furthermore, the accruals quality was measured by discretionary and non-discretionary accruals and estimated using the Modified Jones Model (MJM). Data were collected from a sample of 91 non-financial listed companies in Sri Lanka from 2014 to 2018, and panel regression analysis was utilized to achieve the study objectives.

Findings: The majority of the ratios indicated poor financial performance and condition. In contrast, some ratios yielded contradicting results, attesting that financial information disseminated by financial statements of the Sri Lankan context is less value-relevant. The findings revealed that ratios of net profit to total assets and receivables to sales ratios negatively influence stock returns. The ratios of net profits to sales and working capital to total assets, on the other hand, have a positive impact. Moreover, both forms of accruals play a vital role in explaining stock price movements, with non-discretionary accruals becoming increasingly essential. The findings show that earnings variability is determined by both company conditions and managerial interventions, with business conditions appearing to be more critical.

Originality / Value: The study contributes to expanding existing literature by investigating the issues of value relevance of financial statements within the Sri Lankan context, incorporating both red flags and accrual components.

KEYWORDS
Accruals quality, listed firms, Modified Jones Model, red flag ratios

JEL CLASSIFICATION
C1, G1, M41