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101 Concepts for the Level II Exam

Level II Concept 31: Quality of financial reports


Financial reporting quality
Low High
Low quality reports contain information that is pure fabrication. High-quality reports contain information that is relevant, complete, neutral, and free from error.
Low financial reporting quality impedes assessment of earnings quality and impedes valuation. High financial reporting quality enables assessment.

 

Earnings (results) quality
Low High
Low earnings quality is unsustainable. High earnings quality increases company value.

High earnings quality is sustainable.

 

From an investor’s perspective, the overall quality of financial reports, that is combining reporting quality and earnings quality, can be thought of as a continuous spectrum ranging from highest to lowest as depicted in the diagram below: