- CFA Exams
- CFA Level I Exam
- Topic 3. Financial Statement Analysis
- Learning Module 15. Evaluating Quality of Financial Reports
- Subject 3. Indicators of Earnings Quality
CFA Practice Question
Companies with low earnings quality tend to experience ______ accounting rates of return and relatively ______ excess stock returns in future periods.
A. lower, higher.
B. higher, higher.
C. lower, lower.
Explanation: Companies with high accruals ratios are companies with low earnings quality.
User Contributed Comments 3
| User | Comment |
|---|---|
| pikusa | Can someone explaine? |
| ericczhang | I'm not 100% sure, but I think the idea is that because net income can be divided into an actual cash received component and a change in accruals components (changes in AR, AP, Inventory that reflects over in changes in COGS and expenses), you'd prefer companies that earn more of their net income as cash received. But accounting rate of returns would adjust for the increasing working assets/accruals, and would seem lower than an equivalent company earning the same income without the increases in those accruals. I think? |
| Vedo | key is "future periods". meaning that if you have good quality earnings your business is of better quality and will grow. |