FRA: quality of reporting Flashcards
Profitability misstating
Mechanisms:
1) Aggressive revenue recognition
2) Lessor use of finance lease classification
3) Classifying non-operating gains as operating
Warning signals:
1) CFA revenue growth
3) Higher proportion of revenues is reported in final quarter
Assets / liabilities misstating
Mechanisms:
1) Reclassification from current to non-current (to increase activity ratios)
2) Understating identifiable assets in acquisitions
Warning signals:
1) High goodwill
2) Heavy use of SPV / off-balance sheet
3) Large fluctuations in deferred tax assets
CFO misstating
Mechanisms:
1) Misclassification of cash flows (CFF CFO) - IFRS allows state interest payments and dividends in CFF
2) Misclassification of cash flows (CFI CFO) - primarily by means of lease classification and CFS / trading securities classification
Warning signals:
1) Increase in payables combined with decrease in inventories
2) Capitalized expenditures (flows through CFI)
Beneish model
Probit regression for probability of earning manipulation.
If M-score > -1.78 the probability is significant
1) DSRI - increase in DSR signals aggressive revenue recognition
2) DEPI - decrease in depreciation rate signals earning inflation
Altman Z-score
Model for probability of bankruptcy
1) Net WC / Assets
2) Sales / Assets
3) Operating profit / Assets
4) Market equity / Book liabilities
5) Retained earning / Assets
Identifying accruals manipulation
1) Compare accruals from BS approach (dNOA) and from cash flow approach (NI - CFO - CFI)
2) Compare operating income and CFO + interest payments + tax payments