- CFA Level 2: Financial Reporting Part 3 – Introduction
- Various Definitions of Earnings
- Total Comprehensive Income
- Earnings and Cash Flows
- Derivatives Hedging and Financial Reporting
- Cash Basis Accounting vs. Accrual Basis Accounting
- Management Motivations for Financial Statement Manipulation
- Measures of Earnings Quality
- Analyzing Earnings Quality - the Accruals Ratio
- Financial Reporting Problems and Warning Signs
- Financial Statement Analysis - Ratio Analysis
- Adjusting a Company's Reported Financial Statements

# Analyzing Earnings Quality - the Accruals Ratio

- A company's accrual earnings has two components: cash earnings and aggregate accruals

Accrual Basis Earnings = Cash Earnings + Aggregate Accruals

Aggregate Accruals = Accrual Basis Earnings - Cash Earnings

When aggregate accruals are the dominant component of a company's earnings, mean reversion tends to occur more quickly and so earnings with a high accrual component can be considered lower quality.

**Accruals Ratio**- the accruals ratio is a simple measure for analyzing earnings quality. There are two approaches: the balance sheet approach and the cash flow statement approach.Two approaches to the Accruals Ratio:

Balance sheet approach

Cash flow statement approach

## Balance Sheet Approach to the Accruals Ratio

Steps in evaluating aggregate accruals: the Balance Sheet Approach to the Accruals Ratio

Steps in evaluating aggregate accruals: the Cash Flow Statement Approach to the Accruals Ratio.

NOTE: The two approaches to calculating a company's accruals ratio will not result in the same value, but there is a high correlation between the methodologies.

### You may find these interesting

## Free Guides - Getting Started with R and Python

Enter your name and email address below and we will email you the guides for R programming and Python.