LOS A requires us to:
distinguish between financial reporting quality and quality of reported results (including quality of earnings, cash flow, and balance sheet items)
Financial Reporting Quality refers to the degree of usefulness of the information contained in the financial reports. It refers to the characteristics of the financial statements of the firm. There are certain important characteristics of quality of financial information as provided in the statements, they are:
a. Relevance. The information provided in the financial statements should be useful for its users in actual decision-making.
b. Faithful Representation. The information so presented in the financial statements should reflect the true and fair view of the statements of affairs of a company.
c. Material. The books of accounts must reflect all the information that is material to the decision-making by its users.
d. Complete. The information provided in the financial statements should be complete in all respects.
e. Neutral. The information contained in the financial statements should be free from any sort of bias.
The quality of reported results refers to the earnings and the cash generated by the company’s core economic activities and resulting financial conditions, which are sustainable in nature and result in adequate ROI (return on investments).
Sustainable earnings are those earnings that can be expected to continue in the future. There are certain earrings that may result from extraordinary activities, and these may not continue in the future, for example, gains from the sale of fixed assets. Adequate ROI, on the other hand, means that the economic profits are greater than zero. And, economic profits are greater than zero it the return than greater than the risks taken to earn them. The accounting profit is usually greater than the economic profits.
Without the financial reporting quality, assessing the quality of the financial results is really difficult.