EARNINGS QUALITY - ACCRUALS

[hacky]

We know that:

Aggregate accruals = Accrual based earnings – Cash earnings


Let’s say we have

2013
Cash = 10
Common stock = 10
Liabilities = 0
Earnings = 0

2014
Cash = 0
PPE = 10
Liabilities = 0
Common stock = 10
Earnings = 0

NOA = [Total assets−Cash)−(Total liabilities−Total debt)]

NOA_2013 = 10 - 10 = 0
NOA_2014 = 10 - 0 = 10

Aggregate accruals = 10
Cash earnings = 0
Accrual-based earnings = 0 (since earnings are 0)

Something is wrong!!!

 

[Mosstastic]

I don’t think we use total assets here, I think we use operating assets, so it excludes PPE

 

[hacky]

No (and this is the other unusual thing) it says pag. 391 that:
Total assets - cash = OPERATING ASSETS

 

[hacky]

but SORRY … I find out!!!
CASH earnings in the above exaple is equal to 10
So I have:
Aggregate accruals = 10
Cash earnings = - 10
Accrual-based earnings = 0
and this makes sense!
However this part is poorly written and explained!

 

[hacky]

However there is a problem with financial debt…..
Let’s say we have

2013
Income=0
Cash = 0
Financial Debt = 0
Earnings = 0

2014
Income=0
Cash = 0
PPE = 10
Financial Debt = 10
Earnings = 0

NOA = [Total assets−Cash)−(Total liabilities−Total debt)]

NOA_2013 = 0 - 0 = 0
NOA_2014 = 10 - (10-10) = 10

Aggregate accruals = 10
Cash earnings = 0
Accrual-based earnings = 0

So we would have:
Aggregate accruals = Accrual based earnings – Cash earnings
10=0-0
????????????????????

 

[hacky]

well both the BS method and the IS method are explained differently here: http://www.investopedia.com/university/accounting-earnings-quality/earni...
and I agree much much more with this explanation!
This is another part completely poorly written…congratulations to the author!

 

[MrSmart]

Mosstastic wrote:
I don’t think we use total assets here, I think we use operating assets, so it excludes PPE

Operating assets excludes non-operating assets and subtracts operating liabilities.

 

[hacky]

MrSmart wrote:

Mosstastic wrote:
I don’t think we use total assets here, I think we use operating assets, so it excludes PPE

Operating assets excludes non-operating assets and subtracts operating liabilities.

Using the definition of the CFA
Operating assets = Total assets - Cash
Net operating assets = Operating assets - Total liabilities - Financial debt

 

[defacto]

Investopedia’s derivation is helpful as it makes you realize the shortcuts taken by CFA.Btw you have a mistake in your NOA equation. It should be
Net Operating Assets =Operating assets - (Total liabilities - Financial debt)
If you expand Operating assets you get
Net Operating Assets=Total assets- Cash - Total liabilities + Financial debt
The first 3 terms are the Investopedia equation. The difference is that CFA adds Financial Debt, which is strange if the goal is to get to the change in non-cash assets that derives from the earnings. So we could perfectly consider a PP&E expenditure funded through debt as representing accrual-based earnings? Odd..