Quality of Earnings... Based on Converservatism or Not?

Can anyone clarify this. Schweser states the following: Book 2, Page. 234 “Measuring earnings quality based on conversative earnings is an inferior measure…” Can’t find any direct reference in CFAI book but in the answers for the Mock they write: “Quality of earnings refers to the degree of conservatism in reported earnings”.

I saw this too and chocked it to a poor Schwesser question.

yeah, this has come up before… It seems like sometimes they are looking for conservatism, other times not. Its a wtf thing… If they ask for which of these items represents poor earnings quality: I try to look for something that definitely distorts earnings quality first (accruals, VIE’s, goodwill?). If i cant find anything, i pick the least conservative item.

yeah I saw this in a Qbanker, answer was something about persistence of earnings is a better indicator of quality instead of conservative reporting.

again a fu on Schweser’s part. they have not cleaned up QBank to remove vestiges of last year.

I hate Schweser.

even though they say conservatism is inferior on its own , in almost all cases they prefer the more conservative measure. the other big point is that “earnings” as many of us know it, is just an accounting convention; cash flows are what matters. so generally speaking, be more conservative, adjust cash flows accordingly, and weight the accrual portion of earnings less than the cash flow, and you will win the majority, if not all, of the battles on earnings quality.

You don’t have to actually “weight” anything, right? I mean they will ask you concepts about this, but you don’t have to actually know how to weight the accrual portion low and the cash portion high, right? Cause we weren’t taught that.

nope sorry i wasn’t clear. i didn’t mean that in a literal sense, just more as a general comment. ha i sound like schweser.


its because conservatism isnt really a great measure of earnings quality. this came up in a schweser exam 2pm question. for example, if you change from double declining to straight line deprecation, your earnings are less conservative since you are incrasing ur net income. but it would be foolish to say that youre earnings arent quality. conservativism may only be a consideration if other factors are present. think of this as VaR as a measure of risk. VaR is a poor measure to look at but its still used in conjunction with other things. you wouldnt look at it alone but if other things are bad, you can combine that info with a high VaR.