Class 6 Slides

Question 1

What is earnings quality?

Answer 1

Earnings quality (EQ) is a measure of how much reported earnings correlate with true economic earnings. High quality earnings are presumed to be fair presentations of economic performance, while low quality earnings overstate true earnings.

Question 2

What is earnings management?

Answer 2

Earnings management (EM) occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports. EM is to mislead stakeholders about underlying economic performance or to influence contractual outcomes that depend on reported accounting numbers.

Question 3

What are some types of earnings management?

Answer 3

1. Accruals-based earnings management
2. Classification shifting
3. Recognition vs. disclosure

Question 4

What is the relationship between earnings management and earnings quality?

Answer 4

As earnings management increases, earnings quality decreases (and vice versa); inverse relationship

Question 5

What are the attributes or measure of earnings quality?

Answer 5

1. Predictability
2. Persistence
3. Accrual Quality
4. Smoothness
5. Value relevance
6. Conservatism (bad news first)

Question 6

When companies misrepresent earnings, are they more likely to overstate or understate earnings?

Answer 6

Based on studies, companies that misrepresent earnings are twice as likely to overstate earnings than to understate earnings.