Issue Brief

Accounting Quality

The value of financial accounting is determined largely by its quality. The central concept of accounting quality is that some accounting information is better than other accounting information at communicating what it purports to communicate. Accounting quality is thus of great interest to participants in the financial reporting supply chain. There is, however, no single, widely accepted definition of the term “accounting quality”.  It is interpreted differently by different individuals, organizations and industries. But in the final analysis, all definitions of account quality serve to facilitate value judgments about accounting information.  Although both the FASB and IASB stress the importance of high-quality financial reports, one of the key problems found in prior literature is how to operationalize and measure this quality.

In July 2013, the Securities and Exchange Commission (SEC) today announced three initiatives to build on its Division of Enforcement's efforts to concentrate resources on high-risk areas of the market and bring cutting-edge technology and analytical capacity to bear in its investigations. The initiatives were:

  • The Financial Reporting and Audit Task Force dedicated to detecting fraudulent or improper financial reporting, whose work will enhance the Division's ongoing enforcement efforts related to accounting and disclosure fraud. (See SEC Financial Reporting and Audit Task Force (FRAud);
  • The Microcap Fraud Task Force targeting abusive trading and fraudulent conduct in securities issued by microcap companies, especially those that do not regularly publicly report their financial results;
  • The Center for Risk and Quantitative Analytics employing quantitative data and analysis to profile high-risk behaviors and transactions and support initiatives to detect misconduct, increasing the Division's ability to investigate and prevent conduct that harms investors.

The July press release also announced the creation of the Center for Risk and Quantitative Analytics (CRQA) to serve as an “analytical hub and source of information about characteristics and patterns indicative of possible fraud”. Both the Task Force and the CRQA are drawing on new analytical and technological tools being developed at the SEC, such as the AQM/CIRA.

AQM is an analytical attempt by the SEC to review data. It is a customized analytical tool designed to detect whether a registrant’s financial disclosures differ greatly from its industry peers. CIRCA stands for Corporate Issuer Risk Assessment.  The SEC believes that if a registrant has financial metrics that are outliers for its peer group, that finding could indicate a need for additional scrutiny. The SEC requirement that financial data filed with the SEC be tagged with an Extensible Business Reporting Language (XBRL) format normalizes the data and enables AQM to make comparisons among filers.

The SEC continues to adopt advanced technology, mathematics and computer science to both improve corporate financial disclosures and identify and investigate potential accounting fraud. The SEC’s new tools require corporate financial executives to remain diligent in evaluating accounting accruals, establishing effective internal controls and ensuring proper XBRL labelling for financial disclosures. In addition, the SEC has disclosed a number of risk inducers and risk indicators that will most likely be flagged by AQM/CIRA. 

In 2014, then SEC Chair Mary Jo White reiterated that the Task Force would look for patterns of conduct indicative of financial fraud in areas such as revenue recognition, asset valuations and management estimates. At that time, the Task Force had already generated several investigations.

CFA Institute Viewpoint

Providers of financial information, regardless of size, industry, locale, or maturity, must adhere to the highest standards of transparency, accuracy, relevance, and timeliness in financial reporting. 

By holding all issuers to the same standards, investors would be assured of the highest-quality financial information they need to make informed investment decisions. Information quality is a function of the accounting methods used to develop the numbers, the reliability and transparency of the reported information, and the timeliness with which the information is presented to shareholders.

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