CFA Level I · CFA Level I Exam · Financial Reporting Quality
An analyst finds that a company's balance sheet-based accrual ratio has risen sharply for three consecutive years while operating cash flow has lagged net income. This pattern most likely indicates:
Rising accrual ratios alongside operating cash flow that trails net income most likely indicate lower sustainability of earnings. Earnings driven by non-cash accruals tend to reverse, so the pattern signals weaker earnings quality and possible aggressive accounting rather than conservatism.
- Aimproving earnings quality
- Blower sustainability of reported earningsCorrect
- Ca switch to more conservative accounting
Explanation
Rising accruals with cash flow lagging income suggests earnings rely on non-cash items, which are less likely to persist. This signals lower quality, not improvement or conservatism.
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