Earnings Quality Assessment

Topics: Generally Accepted Accounting Principles, Revenue, Balance sheet Pages: 4 (1372 words) Published: February 4, 2012

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 not depict an accurate picture of a company’s financial position. To assess a company’s reported earnings financial statements users should assess the company’s quality of earnings. According to Schroeder, Clark, and Cathey (2009) quality of earnings is “the degree of correlation between a company’s accounting and its economic income” (p. 158). Accounting income “has been traditionally based on a set of rules and regulations utilizing an historical cost approach” (Kida & Hicks, 1982, p, 41). For example, if a building cost $40,000 and the current market value is $50,000, the building would remain on the books at $40,000, which is the historical cost. Economic income differs from accounting income because “economic Income concepts, are thought of in terms of theoretical constructs, which reflect changing current value” (Kida & Hicks, 1982, p, 41). In the previous example, economic income would have recognized the change in value of the building, which is $10,000 higher than accounting income, the differences in the value of building is a affirmation that earnings quality is necessary to determine the correlation between accounting income and economic income. Following are the various techniques used to assess earnings...
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