APF-CFASpace a
Learning Outcome Statement
Distinguish between Financial
Reporting Quality and quality of reported results.
Da Gui CFA Level I
CFA L1 FRA: Financial Reporting Quality | Felix Gui, MBA, MSF, CFA Level 3 Candidate
Financial reporting quality
≠
Quality of Earnings/Cash Flow/Other Items relevance
High quality financial reporting decision useful
Completeness faithful representation Neutrality
Absence of errors
Quality of Earnings/other items sustainability b Describe a spectrum for assessing financial reporting quality
Basic
Financial reporting quality
Quality of earnings
Three factors: Compliant with GAAP, decision useful, report earnings are sustainable
Best Reporting is compliant with GAAP and decision useful; earnings are sustainable and adequate
Worst
Reporting is compliant with GAAP and decision useful, but earnings quality is low
Reporting is compliant with GAAP, but earnings quality is low and reporting choices and estimates are biased
Reporting is compliant with GAAP, but the amount of earnings is actively managed to increase, decrease, or smooth reported earnings
Reporting is not compliant with GAAP, although the numbers presented are absenced on the company’s actual economic activities
Reporting is not compliant and includes numbers are fictitious or fraudulent
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c
APF-CFASpace
Distinguish between conservative and aggressive accounting
Da Gui
Conservative accounting: if they tend to decrease the company’s reported earnings and financial position
CFA Level I
Aggressive accounting: if they want to increase the company’s reported earnings and financial positions
Aggressive
Capitalizing current period costs
Longer estimates of the lives of depreciable assets
Higher estimates of salvage values
Straight-line depreciation
Delayed recognition of impairments
Less accrual of reserves for bad debt
Smaller valuation allowances on deferred tax assets
Conservative
Expensing current period costs
Shorter estimates of the lives of depreciable assets
Lower estimates of salvage values
Accelerated depreciation
Early recognition of impairments
More accrual of reserves for bad debt
Larger valuation allowances on deferred tax assets
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d
APF-CFASpace
Describe motivations
that might cause management to issue financial reports that are not high quality
Da Gui
Benchmark:

Earnings guidance offered earlier by management

Consensus analyst expectations

Those of the same period in the prior year
Aggressive accounting

Self-interest

Investor, Customer, Supplier
Conservative accounting

Allow earnings shown in future periods, increase probability future earnings will meet benchmark
CFA Level I e
Describe conditions
that are conducive to issuing low-quality, or even fraudulent, financial reports.
Motivations
Opportunity

The company has weak internal controls

The board of directors provides inadequate oversight

Applicable accounting standards provide a large range of acceptable accounting treatments, provide for inconsequential penalties in the case of accounting fraud, or both.
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f g
APF-CFASpace
Describe mechanisms that discipline
financial reporting quality and the potential limitations of those mechanisms.
Describe presentation choices, including non-GAAP measures
,
Da Gui
Rationalization
Regulatory Organizations:
SEC(USA), FCA(UK), IOSCO(International), ESMA(Europe)
In USA, include assessment of firm’s internal control
Private contracts. For example: debt covenants
Non-GAAP measures: exclude some items in order to make firm’s performance look better. Example.
GAAP requires: stricter h that could be used to influence an analyst’s opinion.
Describe accounting methods that could be used to manage earnings, cash flows, and balance sheet items.
IFRS requires:
Revenue Recognition:

Channel stuffing

Bill and hold transaction
Estimates of Credit Losses
Valuation Allowance
Depreciation Methods and Estimates
Amortization and Impairment
Inventory Method
Related-Party Transactions: adjusting the price with private supplier
Capitalization
Other Cash Flow Effects
CFA Level I
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APF-CFASpace i
Describe accounting warning signs and methods for detecting manipulation of information in financial reports
Da Gui CFA Level I

Revenue growth out of line with comparable firms, changes in revenue recognition methods, or lackof transparency about revenue recognition

Decrease over time in turnover ratios

Bill-and-hold, barter, or related-party transactions

Net income not supported by operating cash flows

Capitalization decisions, depreciation methods, useful lives, salvage values out of line with comparable firms

Fourth-quarter earnings patterns not caused by seasonality

Frequent appearance of nonrecurring items

Emphasis on non-GAAP measures, minimal information and disclosure in financial reports
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APF-CFASpace Da Gui CFA Level I
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