ACCOUNTING CLASSIFICATION AND THE PREDICTIVE CONTENT OF EARNINGS

The accounting profession requires that firms disaggregate net income into specific components. Despite the widespread assumption that earni ngs disaggregation is important for assessing firm profitability, ther e is little empirical evidence that the classification scheme actually improves profitability forecasts, We analyze accuracy improvements in out-of-sample forecasts of one-year ahead return-on-equity (ROE) to e xamine the predictive content of earnings disaggregations, The results demonstrate that the classification scheme prescribed by the accounti ng profession does increase the predictive content of reported earning s. We find forecasting improvements from earnings disaggregation. Thes e improvements go beyond separating extraordinary items and discontinu ed operations from the other components of earnings. Further disaggreg ation of earnings (into operating earnings, non-operating earnings and taxes, and special items) improves forecasts of ROE one year ahead.