From what I’ve read, I understand the degree of conservatism should not be used as a measure of earning quality, because accruals revert faster with more aggressive policies. For example, double-declining method doesn’t result in lower earning quality compared to straight-line. But I’ve seen many practice exams saying aggressive accounting leads to lower earning Q (ex. Schweser Vol2 exam 2AM #28) High accrual ratios, securitization, and off-balance accounting are a sign of low earning quality. But what about depreciation method or R&D capitalization?
SL deprec is more aggressive than DDB. Capitalizing R&D, which should be expensed usually, is probably pretty aggressive. Not sure if that answers your question.
Sorry, typo. I meant to say that double-declining method doesn’t result in “higher” earning quality compared to straight-line. My question is: Does accounting conservatism, such as depreciation method, affect earning quality?
No, depreciation method choice is fine as long as they are consistent with it. But the main problem is manipulating estimates such as salvage and useful lives.
zestzorb Wrote: ------------------------------------------------------- > Does accounting conservatism, such as depreciation > method, affect earning quality? this is like the whole point of FRA. accounting choices effect earnings quality. and analyst job is to analyze these choices and effects. if I am taxi driver and i depreciate my car for 7 years, then i magically say it will last 50 years and i will depreciate it over 5 decades, how good is my earnings quality?
Thanks Dreary and prophets. So we can conclude that accounting methods play no role but what’s important is the accounting estimates.
ofc accounting methods play a role… if i account for a security as held for trading and it makes a lot of money and i account for other securities as available for sale and it loses a ton, then go to wall st. and tell everyone how amazing my co’s earnings are… ??? saying accounting methods have no role, is like saying words have no meaning – only action matters. if so then how does obama get elected? lol… !
No. I said depreciation method choice is fine, but accounting methods do matter of course.