R.18 Evaluating Quality of Financial Reports Flashcards
1
Q
Spectrum of better to poorer quality?
Two questions analysts should ask?
A
Best to worst quality
- GAAP, decision-useful, sustainable, and adequate returns
- GAAP, decision-useful, but not sustainable
- GAAP, but biased choices or earnings management
- Non-compliant accounting
- Fictitious transactions
The analyst should focus on two questions:
- Are the financial reports GAAP-compliant and decision-useful?
- Do the results provide an adequate level of return and are they sustainable?
2
Q
Quality problems: Reported Amounts and Timing of Recognition
A
Examples of accounting choices that affect current period results:
• Aggressive, premature, and fictitious revenue recognition
• Conservative revenue recognition
• Omission and delayed recognition of expenses
• Understatement of contingent liabilities
• Overstatement of financial assets and understatement of financial liabilities
3
Q
Quality problems: Classification
A
- Classification choices typically affect just one financial statement.
- Balance sheet
- A/R reduced by moving some A/R to a controlled entity. Amount transferred remains on balance sheet but its not part of actual Accounts Receivable balance.
- Statement of comprehensive income
- May make earning look more sustainable:
- Classifying operating expenses as non-operating
- Classifying non-operating revenue as operating
- May make earning look more sustainable:
- Cash flow statement.
- -Classify the sale of long-term assets as an operating activity.
- Capitalize rather than expense operating expenditures to classify the outflow as an investing activity rather than an operating activity.
4
Q
Other quality problems
A
- Problems with mergers and acquisitions
- Compliant account standards may not reflect economic reality
5
Q
Balance Sheet quality indicators
A
6
Q
Cash Flow Quality indicators
A
7
Q
Benish Model
A
8
Q
Earnings Persistence and Related Measures of Accrual
A
