Earnings Quality

Isn’t this contradictory of what we learned in L1? If reporting quality is low, you cannot have earnings quality high.

Rocco Salvatore was CFO of a company until he resigned in the current accounting period. In his letter of resignation, Salvatore described an environment in which the CEO constantly threatened that Salvatore would be fired if he failed to find ways to show better results for the firm. Salvatore admitted to allowing sales reps to provide kickbacks to customers in order to encourage more sales, and disguising them as payments to suppliers. Although the company had sufficient actual earnings for an adequate, sustainable return to capital, he admitted to booking fictitious revenue sufficient for the CEO to receive his bonuses. This firm’s reporting and results could best be characterized as:

a. low earnings quality and low reporting quality.

b. high earnings quality and low reporting quality.

c. high earnings quality and moderate reporting quality.

I thought A was the answer because you cannot have good earnings quality if the reporting quality is low because you cannot determine quality… However, answer is B.

I believe that it’s the other way round: you cannot have high reporting quality without high earnings quality.

^ What if you were GAAP compliant, with objective decision-useful accounting, but you report losses. Isn’t that high quality reporting with poor earnings quality? Reading 19 conclusion, bullet 4: "…“high quality earnings assumes reporting quality is high”. If reporting quality is low, then earnings quality is low (results, no matter how strong, are not decision useful).

I failed level 2 last year so correct me if I’m wrong.