Week 6 - Earnings Quality Flashcards
(14 cards)
What does financial reporting quality refer to
the accuracy with which a company’s reported
financials reflect its operating performance, and
their usefulness for forecasting future cash flows
How do choices in accounting methods and estimates impact the preparation of financial statements, and what potential risk do they introduce?
Choices in accounting methods and estimates allow financial statement preparers to present information in a way that best fits the business context. However, this discretion can also be used to manipulate accounting results to some extent, potentially misrepresenting the company’s true financial position.
What is earnings management
The use of accounting, or non-accounting, methods
allowed under GAAP and law to manage earnings figures toward a desirable direction or level
usually NI, or
NI adjusted for non-recurring items (often analysts’
focus)
What is accounting manipulation
a spectrum ranging from acceptable but potentially
misleading reporting to borderline “fraudulent
misreporting
What are the three main types of financial misstatements, and how do they differ?
Errors – Unintentional mistakes due to weak accounting or control systems.
Fraud – Intentional misstatements involving fictitious transactions, altered records, or concealment of losses/liabilities.
Accounting Manipulation – Misstatements in gray areas, often hard to prove as intentional, e.g., cookie-jar reserves or early revenue recognition presented as errors or prudence.
What are the ways we can measure earnings quality
by using the accruals approach
What does the accruals approach show
as it shows us how much a company is prone to manipulation. Higher Accruals ratio=more room for manipulation. Lower accruals ratio= less room for manipulation
what are the 2 approaches to the accruals ratio
Cash flow approach and the balance sheet approach
what is the cash flow accrual approach formula
(Net income -(CFI +CFO )/ average NOA
Cash flow from operating activities +cash flow from investing activities)
How do we work out NOA and Average NOA
NOA= Operating assets (TA- Cash - ST investments ) - (TL-Total debt) operating liabilities
- these need to be classified
to work out average add 2 years NOA figures and divide by 2
what is the accruals ratio
Total accruals/ Average NOA
What is the formuala for total accruals
NI-Cash earnings
What is the formula for ratios using the balance sheet approach and
Change in NOA/ Average NOA
What we mean by change is change from 1 period from the previous period
when we are making an analysis of overall earning quality what do we mention
we mention if earnings quality has improved or worsened via the ratio analysis if its low it means that improved, if the ratio is higher it means that earnings quality has worsened
