Fair Value Accounting - Quality of Earnings

Topics: Generally Accepted Accounting Principles, Asset, Balance sheet Pages: 2 (437 words) Published: November 13, 2008
Under fair value accounting, earnings of a firm constitutes three broad components namely asset income, realized gains and unrealized gains. What impact does this have on a firm’s earnings quality given that the main shift from current accounting standards is the inclusion of unrealized gains into earnings computation? Often, it holds true that what matters is not how much a firm makes, but how it makes its money . Investors value earnings that are sustainable, inherent to a firm’s business and not those resulting from short term measures to boost their bottom-line hence bringing to mind the issue of quantity of earnings, versus quality of earnings. Including unrealized gains may boost the amount of earnings, but with regards to quality, how exactly does it translate to a true reflection of how much a firm is inherently making. To further examine this aspect, quality is categorized into three factors; Repeatability, Controllability and if the earnings are bankable. Gains derived from one-off transactions are never a good indication of a firm’s inherent income generating ability. Sale of assets for one is never repeatable. Similarly, by including a firm’s gains from assets and liabilities, both realized and unrealized, it brings into question how repeatable such earnings can be. Controllability of earnings refers to how much control a firm has over its earnings; Exchange rate differences and market fluctuations affect the valuation of a firm’s assets and liabilities and since fair value accounting states for such changes to be included in a firm’s earnings, the control a firm has over its earnings seem to have waned under the susceptibility of market conditions. The final aspect of quality refers to those earnings that are cash sales based; Sales that can be deposited into the bank. Once again, this aspect is compromised given the large uncertainty of the actual collectivity of the earnings reported. Furthermore, the constant need for revaluation of a firm’s...
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