Module 29.1: Reporting Quality Flashcards
Does compliance with GAAP result in financial reporting of the highest quality? if no, why?
no, because gaap provides methods, estimates, and specific treatment of many items.
What dictates decision useful reporting quality?
must be decision useful: two characteristics of decision useful are relevance and faithful representation.
relevance - refers to the fact information presented is useful to users making decisions.
faithful representation - encompasses the qualities of completeness, neutrality, and the absence of errors.
How is the quality of earnings measured?
can be based on sustainability of the earnings as well as their level.
sustainability can be evaluated by determining the proportion of reported earnings that can be expected to continue.
Is it possible for a firm to have high financial reporting quality but a low quality of reported earnings?
Yes
What is the categorization of financial statement reporting from best to worst taking into account reporting quality and quality of earnings?
1) reporting is compliant with GAAP, decision useful, sustainable earnings
2) reporting is compliant with GAAP, decision useful, but earning quality is low
3) reporting is compliant with GAAP, but quality is low and estimates are biased
4) reporting is compliant with GAAP, but the amount of earnings are actively managed to increase or smooth earnings
5) reporting is not compliant with GAAP, although the numbers presented are based on the company’s actual economic activities
6) reporting is not compliant with GAAP and fraudulent.
What is conservative acccounting?
choices made by GAAP if the tend to decrease the company’s earning and financial position.
What is aggressive accounting?
choices made by GAAP if they tend to increase the company’s earnings and financial position.
What is earnings smoothing?
the use of conservative and aggresive accounting by changing accrued liabilities and assets that are based on management estimates.
What are some of the benefits of conservative accounting?
1) reduces probability that uses can claim they were mislead
2) reduces current period tax liability
3) protects interest of those who have less complete information that company management
What are three main reasons managers would be motivated to use aggressive accounting choices?
1) earnings guidance offered earlier by management
2) consensus analyst expectations
3) those of the same period in the prior year
4) violating debt covenants
These will be career oriented.
What are three main circumstances in which low quality financial reporting is more porbable?
1) the company has weak internal controls
2) the board of directors provides inadequate oversight
3) applicable accounting standard provide a large range of acceptable accounting treatments (“rationalization”).
What do securities regulators typically require? 6 things.
1) registration process
2) specific disclosure and reporting requirements
3) independent audit
4) statement of financial condition made by management
5) signed statement by the person responsible for the preparation of the reports
6) a review process of newly registered securities
What are the requirements by GAAP if a firm decides to report non-GAAP measures? 5 things.
1) display the most comparable GAAP measure
2) provide explanation by management
3) reconcile the differences between the non GAAP mesaure to the most comparable GAAP measure
4) disclose other purposes for which the firm uses non-GAAP measure
5) include, in any non-GAAP measure, any items that are likely to recur in the future.
What are the requirements by IFRS if a firm decides to report non-IFRS measures? 2 things.
1) Define and explain the relevance of such non-IFRS measures
2) reoncile the difference between the non-IFRS measure and most comparable IFRS measure.
