Earnings Quality Assessment Essay

1360 Words Jan 20th, 2012 6 Pages
Abstract

A quality of earning assessment is a tool used by analyst to determine the correlation between accounting income and economic income. The techniques to analyze accounting income and economic income include: comparing accounting principles, reviewing changes in accounting principles, analyzing discretionary and warranty expenditures, understanding replacement cost of assets and managements and auditors opinion of the company. A quality of earnings assessment of PepsiCo is applied to the various techniques to analyze accounting income and economic income.

Discuss Measures That may be used to asses the quality of a firms reported earnings.
Companies prepare their financial statements based on accounting income, which does
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For example, company A use FIFO to report cost of goods sold and company B use LIFO to report cost of goods sold. During periods of inflation FIFO would produce a higher net income. According to Schroeder, Clark, and Cathey (2009), “compare the accounting principles employed by the company with those generally used in the industry and by the competition. Do the principles used by the company inflate earnings” (p. 158).
B. Changes in accounting estimates can inflate earnings. For example, if the life of an asset is estimated as five years and management change the estimate to 10 years, depreciation expense would decrease and net income would increase. Schroeder, Clark, andCathey (2009), states “review recent change in accounting principles and changes in estimates to determine if they inflate earnings” (p. 158).
C. To inflate earnings an organization could reduce discretionary expenses. Schroeder, Clark and Cathey (200) states, “determine if discretionary expenditures, such as advertising have been postponed by comparing them to those of previous periods” (p. 158).
D. Companies may increase net income by not recording expenses “assess whether some expenses such as warranty expense, are not reflected on the income statement” (Schroeder, Clark, &Cathey, 2009, p. 158).
E. Analyze the replacement cost of a company’s inventory and assets and “assess whether the company generates sufficient cash flow to replace it

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