LM 9: Financial Reporting Quality

Question 1

What is financial reporting quality?

Answer 1

quality of information in financial reports (accuracy, relevancy, etc.)

Question 2

What is earnings quality?

Answer 2

quality of earnings, cash flow, and balance sheet items

Question 3

What are the 6 quality spectrum of financial reports, describe them? GGBWNF

Answer 3

1. GAAP, decision-useful, sustainable, and adequate returns
2. GAAP, decision-useful, but not sustainable (earnings don’t meet investor demand or do not come from reliable sources)
3. biased account choices (eg. Aggressive, conservative, etc)
4. within GAAP, but with “earnings management” (management intentional choices to bias financial reports)
5. Non-compliant accounting
6. Fiction transactions

Question 4

What are the 3 types of bias for biased account choices? ACU

Answer 4

1. aggressive choices
2. conservative choices
3. understatement of volatility

Question 5

What 2 things does aggressive accounting choice do and what are the 2 impacts?

Answer 5

1. recognize revenue early
2. defer recognition of expenses

impacts
1. increase current period profits
2. likely decrease reported profits and financial position in later periods

Question 6

What 2 things does conservative accounting choice do and what is the impact?

Answer 6

1. delay revenue recognition
2. accelerate recognition of expenses

impact
lower current period reported profits

Question 7

What is unbiased financial reporting?

Answer 7

neither aggressive or conservative

Question 8

What is bias in the application of accounting standards?

Answer 8

accounting standards often require judgement

Question 9

What are 3 reasons a company would issue low quality reports? OMR

Answer 9

1. opportunity (poor internal controls)
2. motivation (personal compensation)
3. rationalization (justify actions)

Question 10

What are 6 requirements by regulatory authorities that directly impact financial reporting quality? RDAMRE

Answer 10

1. registration requirements
2. disclosure requirements
3. auditing requirements
4. management commentaries
5. responsibility statements
6. enforcement mechanisms

Question 11

What are 4 limitations of audit opinions? IOAA

Answer 11

1. it is based on information prepared by company
2. only a sample is reviewed
3. audit is not designed to detect fraud
4. auditor is being paid by the company being audited

Question 12

What are 5 accounting choices and estimates that can affect earnings and balance sheets? CEVDC

Answer 12

1. choice of inventory valuation method
2. estimates for uncollectible accounts
3. valuation allowance
4. depreciation method
5. capitalization

Question 13

What are the 5 main warning signs to pay attention to in the detection of financial reporting quality issues? RICRC

Answer 13

1. revenue
2. inventory
3. capitalization policies
4. relationship between cash flow and net income
5. company culture

Question 14

What is understatement of volatility type is bias for account bias?

Answer 14

Conservative choices when company performs well & aggressive choices when company performances poorly, smoothing out earnings

Question 15

What is the effect of low financial reporting quality despite high or low earnings quality?

Answer 15

Low financial reporting quality impedes assessment of earnings quality and impedes valuation

Question 16

What is the effect of high financial reporting quality but low earnings quality?

Answer 16

HIGH financial reporting quality enables assessment. LOW earnings quality decreases company value.

Question 17

What is the effect of high financial reporting quality and high earnings quality?

Answer 17

HIGH financial reporting quality enables assessment. HIGH earnings quality increases company value