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Quality of Earnings
D E L O I T T E & T O U C H E

IQ

Integrity & Quality

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IQ
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Quality of Earnings

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Integrity and quality have always been a focus of the American financial reporting system. However, recent events have shown that there is room for improvement. These events, coupled with increasinglycomplex global business structures, demand that the time for improvement in quality and integrity is now. We recognize that the current state of the financial reporting system and the profession is not perfect. Deloitte & Touche is committed to being leaders for the profession, our clients, and other companies on the journey of improvement.
Although the faith of the investing public will berestored, investors are certain to seek more information and ask more questions regarding the quality of financial reporting and a company’s financial condition. The investing public’s needs and demands regarding the quality of financial reporting and understanding a company’s financial condition have multiple aspects. These include, but certainly are not limited to, the quality of earnings,liquidity, strength of the balance sheet, and transparency of an enterprise’s financial reporting—each of which, while intertwined, is a separate, complex subject. Because earnings are at the forefront of the investing public’s mind, this document focuses on how audit committee members, boards, management, and other financial statement users can better understand and assess the quality of earnings. Role ofManagement and the Audit Committee Relative to Quality of Earnings. Management has always had responsibility for the selection and application of accounting principles, as well as the underlying estimates and judgments used in applying such principles. Hence, management is ultimately responsible for the quality of earnings. In contrast, the role of the audit committee has evolved over time. Thisevolution saw significant changes in 1999 after The Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees issued its report, which resulted in the implementation of various rules and standards by the stock exchanges, regulatory bodies, and standards-setting bodies. Among other things, the new rules and standards require discussion among the audit committee, management,and the external auditors regarding the quality, not just the acceptability, of the entity’s accounting principles as applied in the financial statements. It is important to recognize that the quality of accounting principles is not the same as the quality of earnings, but the two are inherently linked in that the judgments used in selecting and applying such principles directly impact thequality of earnings.
Deloitte & Touche IQ

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Quality of Earnings

Deloitte & Touche Integrity & Quality

External Auditors’ Communication with Audit Committees. The American Institute of Certified Public Accountants’ Statement on Auditing Standards (SAS) No. 90, Audit Committee Communications, established the requirement for external auditors and the audit committee to discuss the quality ofthe accounting principles used in the entity’s financial statements. Specifically, SAS No. 90 requires that the external auditor: “Discuss with the audit committee the auditor's judgments about the quality, not just the acceptability, of the entity’s accounting principles as applied in its financial reporting. The discussion should be open and frank and generally should include such matters as theconsistency of the entity's accounting policies and their application, and the clarity and completeness of the entity's financial statements, which include related disclosures. The discussion should also include items that have a significant impact on the representational faithfulness, verifiability, and neutrality of the accounting information included in the financial statements. Examples of...