Research On Earnings Quality

Accounting earnings is important information provided by the enterprises to stakeholders in accordance with the accounting standards and accounting policy, with the aim to help stakeholders to achieve their specific economic decision-making.Accounting earnings is the core concept of accounting. It measures the input-output efficiency, and is one of the measurements of ability to create social wealth. Accounting earnings always plays an important role in the measurement process of economic activity efficiency, and has been being the critical factor in all kinds of contractual relationship. Accounting earnings quality has a material effect on the rationality of users’decision-making, and a comprehensive study on accounting earnings quality is helpful to discern the quality of earnings, and improve its decision usefulness.Research on earnings quality made a start roughly in 1930s with the goal of finding those securities which are undervalued or overvalued. Variable definitions of earnings quality put forward from researchers in conformity with their respective researching objectives. The term was used as early as 1934 by Graham and Dodd in Security Analysis, when they describe the Wall Street equity valuation model as earnings per share times a "coefficient of quality." Their description of the quality coefficient implies their definition of quality:the coefficient reflects dividend policy, as well as firm-specific characteristics such as "size, reputation, financial position and prospects," and the nature of the firm’s operations, as well as macroeconomic factors including "temper of the general market" (Graham and Dodd,1934). This is the earlier description of earnings quality. "Coefficient of quality" is similar to P/E ratio.In the sequence of publishing time of literature domestic and abroad, we show their respective definition of earnings quality as follows. Bernstein and Siegel (1979) define quality of earnings as a measure (qualitative) of the comparative integrity, reliability, and predictive ability of reported earnings. Pratt defines earnings quality as the extent to which n et income reported on the income statement differs from true earnings. Schipper and Vincent (2003) define earnings quality as the extent to which reported earnings faithfully represent Hicks’s income. Patricia Dechow (2010) defines earnings quality as "Higher quality earnings provide more information about the features of a firm’s financial performance that are relevant to a specific decision made by a specific decision-maker."Though late probably in the 90’s of last century in our country on the earnings quality research emerged, earnings quality research has been enriched with the development of China’s securities market. Qiu Yun (1997) defines earnings quality as the deviation degree between enterprise report profit and operating performance. Yu Xinpei defines quality of accounting as being a qualified product, the degree of accounting earnings can be used reliably by users of financial statements. Zhou Bin defines earnings quality as the extent that report accounting earnings reflects the company profit economic reality. Cheng Xiaoke defines earnings quality as the investor’s decision-making relevance of earnings information, namely the current and historical earnings to predict future performance (the future free cash flow) ability. Shao jun defines it as the inherent characteristics of earnings information to meet the requirements of information users. Earnings quality definition evolves from qualitative description to user-satisfaction-orientation approach. In fact, the above definitions express variable layers of earnings quality.Quality definition consists of three hierarchies. The description of the concept can be roughly divided into three kinds. The first kind is conformance quality point of view and quality means meeting certain specifications and standards, emphasizing the measurable characteristic of quality. Secondly, the applicability concept of quality. Consumers are assumed not understanding the standards set by the production specification, parameter and other specific requirements, and hence quality should be explained by "applicability". Applicability is composed of those characteristics which consumers used to judge product’s benefit for them. Thirdly, the comprehensive description of quality. ISO9000 quality standards 2008 Edition define quality as the inherent characteristics of product to meet the requirements of consumption. The domestic literature explanation about the meaning of earnings quality contains these three layers of quality. Early papers definitions are from the conformity perspective; then with the deepening of the research, definition is related to decision-makers needs. With respect to users’ needs,which evolves to the applicability explanation of earnings quality, and the characteristics of earnings quality are summarized to give earnings quality concrete assessment.Financial market development provides earnings quality research with ample data and motivation. Intensive attention to the accounting earnings quality in U.S.A. is in the year of 2001 when American Accounting Association (AAA) took in a earnings quality research project, followed by a special issue in which articles were published on earnings quality. Accounting earnings quality research was motivated by the above activities. According to the approaches used in earnings quality research, the earnings quality research process will be divided into two stages, with Beaver (1968) and Ball, Brown (1967,1968) using the equity market price response to earnings to infer the accounting earnings quality as the time watershed. In the 1st stage the research is based on norms. Academic accounting research focused on evaluating the "earnings quality" in terms of conformity to a consistent measurement system or conceptual framework, much of the debate focused on whether earnings should be measured using historical cost with matching (Daines,1929; Littleton,1956; Paton and Littleton,1940), replacement cost or entry values (Sterling,1970), future discounted cash flows (Fisher,1907,1930), or net realizable values or exit costs (Chambers,1956,1965). In the 2nd stage, return-based earnings quality research using financial market data should not be surprising. Beginning with Beaver (1968) and Ball and Brown (1967.1968), academic accounting researchers have used equity market responses to earnings to infer quality. At this stage, accounting theory gradually formed three kinds of views on accounting earnings function which are information view, valuation view and contract view. Earnings information content, net earnings surplus concepts are formed and important development and innovation of relevant disciplines, i.e. enterprises economic theory, institution economy and proprietary theory, introduces and enriches the potential use of accounting information.A measure of accounting earnings quality is a challenge to the research on earnings quality. As mentioned before, the earnings determination is preliminary assessment of earnings. Earnings determination is accounting identification, measurement and reporting of earnings in accordance with the enterprise’s accounting policy. The formulation of accounting policy is based on accounting standards and accounting system which are established by standard-setters comprehensively considering accounting theory, economic status, legal system, education level and other environmental factors. So. the basic quality of accounting earnings quality is determined by the financial accounting theory, accounting standard (including accounting system), and environmental factors. Prior earnings quality research focuses on conformity characteristic of earnings determination. Accounting standard is the result of logical reasoning and value judgment:accounting theory comprises of concept, judgment and inference; environmental factors shaping the different accounting standards though most countries and regions have been striving for accounting convergence.The second hierarchy of product or service quality is its usefulness to the consumers, and the same for earnings quality assessment. Earnings quality research will miss its direction and motivation if fail to take information users demand for earnings information. Improve the usefulness of accounting information is the prerequisite for the existence of all accounting related industries. And the understanding of accounting income stakeholders in the income distribution relations and changing in the analysis of the yield, appeals to historical and dynamic perspective on the accounting earnings of stakeholders help to see the specific implication of "usefulness".Quality is the satisfaction degree of a set of inherent characteristics to meet the requirements, and earnings quality characteristics are the inherent qualities that are helpful for users to make decision. Although foreign or domestic researches have clearly describe the quality characteristics of accounting information, but general and abstract quality characteristics are not enough to understand earnings quality and specific quantitative quality characteristics are needed to stipulate earnings quality, for example, earnings quality, discretionary accruals, earnings smoothness, timely loss recognition and target beating etc.The basic characteristics of accounting earnings quality is determined by the conceptual framework and accounting standards. Ownership theory defines the scope of accounting income and distribution; the capital maintenance theory distincts between return of capital and return on capital; accounting period, accrual basis, and conservatism contribute to earnings persistence, accruals and conservatism quality propertiis of accounting earnings; earnings determination approaches evolve from the balance sheet approach to the income statement approach then presently towards the comprehensive income, and this process reflects economic profit concept influences accounting earnings:economic profit determines the future direction of accounting earnings, but accounting earnings itself has to follow its own development logic as the result of the pursuit of objectivity.Connotation of earnings quality clearly defines quality evaluation must be with the accounting information demand associated. The shareholders, creditors, managers, auditors and government are the 5 critical stakeholders of earnings. Accounting information affects their income-risk characteristics. They are not only determince quality of accounting earnings, but also influenced by the earnings quality.Proxy variables of earnings quality based on market price are earnings response coefficient and goodness of fit R2. In the earnings-return model, Returnt=α+β Earningst+ εt, larger β value is a indicator of much more informativeness in earnings, and larger R2 are indicator of higher value-relevance.In the literature of foreign, domestic research, investors’ reaction to the earnings is represented by returns, price changes, the volume change, and there are some shortcomings even if they are straightforward. Influencing factors of earnings response coefficient also include β,capital structure of company (financial leverage), earnings persistence, growth and price information in addition to accounting earnings quality. In the examination of earnings quality with earnings quality as the independent variable, other factors except earnings quality should be controlled. Otherwise, the conclusion may be interfered.In the analysis and evaluation of accounting earnings quality based on the financial statements, factors which can have influence on the earnings quality, i.e. asset quality, capital structure and other factors and so on, are discussed. Earnings quality evaluation financial index are put forward and reasonable weigh for each index is established by employing statistical methods. Furthermore, listed companies’data from year 2007 to 2011 is examined by the statistic model. Accounting earnings quality recognition is useful information to users, and who should be the competent preparer of the earnings quality assessment report? Responsibility for completion of the earnings quality assessment could fall to a variety of groups, including financial analysts, corporate management, and auditors. The subject may perform this function may have financial analysts, managers, auditors and other. Given management’s inherent bias, however, an evaluation of its own quality of earnings would not be viewed by the public as reliable. Equity and credit analysts conduct their own assessments of earnings quality for companies the cover. The analysts are not, however, privy to the considerable evidence that auditors gather during their audits. In addition, the analysts are often not independent of the companies they cover, and they do not employ uniform procedures for measuring earnings quality. The auditor’s advantage is very obvious advantages, such as, independence. Auditors are the most logical choice to be responsible for the earnings quality assessment, i.e. the auditors would be independent evaluators of earnings quality.The foreign and domestic literatures are high perspicacity accumulations of earnings quality from accounting academic researchers and accounting practitioners. Based on their research results, this article can discuss the related earnings quality issues. The aspiration of knowledge encouraged me to express these words; but at the same time, I really worry about misunderstanding of knowledge. I hope criticisms and suggestions they are invaluable for me from readers for any defects in this article.