Module 10 · FRA

Financial Reporting Quality

EN: Quality spectrum, earnings management, and Beneish/Altman screens.
VN: Phổ chất lượng báo cáo, quản trị lợi nhuận và mô hình phát hiện gian lận.

1. Quality Spectrum (Highest → Lowest) Concept

1. GAAP, decision-useful, sustainable, adequate The ideal.
2. GAAP, decision-useful, but low-quality earnings Real but not sustainable.
3. GAAP, but biased choices Aggressive/conservative accounting.
4. GAAP, but earnings management Real activities or accounting tricks.
5. Departures from GAAP Non-compliant.
6. Fictitious transactions Outright fraud.

2. Common Earnings Manipulation Tactics Concept

Revenue Bill-and-hold, channel stuffing, premature recognition.
Cost capitalize WorldCom — capitalizing operating costs as PP&E.
Reserves Cookie-jar reserves — over-reserve in good years, release in bad.
Big bath Front-loading losses to inflate future earnings.
Off-B/S Special-purpose entities (Enron).

3. Beneish M-Score Concept

8-variable model. Higher M-score (> −1.78) suggests possible earnings manipulation. Inputs include DSRI (days' sales receivables), GMI (gross margin), AQI (asset quality), SGI (sales growth), DEPI, SGAI, accruals, leverage.

4. Altman Z-Score Concept

\[ Z = 1.2 X_1 + 1.4 X_2 + 3.3 X_3 + 0.6 X_4 + 1.0 X_5 \]

Variables (working-cap-to-assets, etc.) and zones

Z > 2.99 Safe zone.
1.81 ≤ Z ≤ 2.99 Grey zone.
Z < 1.81 Distress zone — high bankruptcy risk.

Practice problem

X1=0.20, X2=0.30, X3=0.10, X4=1.0, X5=1.5. Compute Z and zone.

Show solution

Z = 1.2(0.20) + 1.4(0.30) + 3.3(0.10) + 0.6(1.0) + 1.0(1.5)

= 0.24 + 0.42 + 0.33 + 0.60 + 1.50

Z = 3.09 → Safe zone

Practice problem Practice

Practice problem

A firm capitalizes routine maintenance costs as PP&E rather than expensing them. What is the effect on near-term financials?

Show solution

Capitalize → expense moved to balance sheet.

Higher current NI, higher assets, higher equity, lower expenses now.

Future periods: depreciation rises, NI lower than otherwise.

Earnings management — overstates current NI; classic 'capitalize vs expense' manipulation (e.g. WorldCom).