Earnings Quality Flashcards
Earnings Quality Depends on these two things
1) Underlying Economic Performance of the firm, and
2) How well the accounting system measures performance
How well the accounting system measures performance depends on these three factors:
1) Multiple Decision Models,
2) Limited set of pre-determined measurement principles, and
3) Measurement involves ESTIMATES AND JUDGMENTS
Measurement Involved Estimates and Judgments with the potential for:
Unintentional errors and intentional bias (earnings management)
Why allow discretion?
Benefit (managers can use the flexibility in GAAP to best represent their economic position and 2) Cost: Increases managers ability to intentionally bias.
AICPA 5 threats to auditor independence (ASS IF)
1) Advocacy
2) Self-Interest
3) Self-Review
4) Intimidation
5) Familiarity
How do we constrain intentional bias?
1) Market Incentives
2) Government Regulations
When does earnings management occur?
When managers use judgment in financial reporting and structuring transactions to alter financial reports to mislead investors or influence contractual outcomes.
What type of earnings management is when managers make accounting choices used to represent the underlying activities of the firm in an effort to influence the output of the accounting system?
Accrual Management
What type of earnings management allows to undertake actions that change the timing or structure of an operation, investment, or financing transaction in an effort to influence the output of the accounting system?
Real Earnings Management
What’s the difference between purchased intangibles and internally created intangibles?
Purchased are recorded at cost and basis includes all costs necessary to make it ready for it’s intended use. Internally created are expensed and only capitalized direct costs with development like legal costs.
What internally generated intangibles assets are capitalized for GAAP?
Second stage which includes software production and relevant costs related to that.
What’s the difference between limited-life and indefinite life intangibles?
Limited life can be amortized and are impaired based on their recoverability and fair value; while indefinite cannot be amortized but will be tested for impairment. (other than Goodwill)
