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Earnings Quality

In our real life, the value of assets cannot be estimated perfectly because we can't be certain for the future cash flows that the asset generates and also we can't be certain for the discount rate. Because of the uncertainty for the future cash flows and the discount rate, we cannot complete the balance sheet if we do have the income statement first. Can you explain how the uncertainty is related to earnings quality and how the uncertainty can be reduced?

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The uncertainty is related to earnings quality in a few significant ways. Although most people agree on the same basic definition of earnings quality, the problem that needs to be factored in is that each criteria used by different individuals to determine earnings quality will be different, and will also be in-part based on the individual's perceptions of current circumstances. When we talk about earnings quality, we're looking at the "real" ways that a company was able to increase their profit, either by increased sales or reduced expenses. We are not including the factors that are attributed to adjusted prices from increases or decreases in inflation, or from adjustments to inventory or to other processes in the manufacture of the product. Instead, we're ...

Solution Summary

In our real life, the value of assets cannot be estimated perfectly because we can't be certain for the future cash flows that the asset generates and also we can't be certain for the discount rate. Because of the uncertainty for the future cash flows and the discount rate, we cannot complete the balance sheet if we do have the income statement first. Can you explain how the uncertainty is related to earnings quality and how the uncertainty can be reduced?

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