CHAPTER 16
EVALUATING FINANCIAL REPORTING QUALITY
LEARNING OUTCOMES
After completing this chapter, you will be able to do the following:
- Contrast cash-basis and accrual-basis accounting, and explain why accounting discretion exists in an accrual accounting system.
- Describe the relation between the level of accruals and the persistence of earnings and the relative multiples that the cash and accrual components of earnings should rationally receive in valuation.
- Explain opportunities and motivations for management to intervene in the external financial reporting process and mechanisms that discipline such intervention.
- Describe earnings quality and measures of earnings quality, and compare the earnings quality of peer companies.
- Explain mean reversion in earnings and how the accruals component of earnings affects the speed of mean reversion.
- Explain potential problems that affect the quality of financial reporting, including revenue recognition, expense recognition, balance sheet issues, and cash flow statement issues, and interpret warning signs of these potential problems.
SUMMARY OVERVIEW
- Financial reporting quality relates to the accuracy with which a company’s reported financial statements reflect its operating performance and to their usefulness for forecasting future cash flows. Understanding the properties of accruals is critical for understanding and evaluating financial reporting quality.
- The application of accrual accounting makes necessary use of judgment and discretion. ...
