Financial Reporting Quality: Red Flages and Accounting Warning Signs

Management may be motivated to overstate net income to:

1. Meet earnings expectations.
2. Remain in compliance with lending covenants.
3. Receive higher incentive compensation.

Management ma be motivated to underreport earnings to:

1. Obtain trade relief in the form of quotas or protective tariffs.
2. Negotiate favorable terms from creditors.
3. Negotiate favorable labor union contracts.

Low quality earnings are th result of:

1. Selecting acceptable accounting principles that misrepresent the economics of a transaction.
2. Structuring transactions to achieve a desired outcome.
3. Using aggressive or unrealistic estimates and assumptions.
4. Exploiting the intent of an accounting principle.