Nonprofessional Investors’ Framework for Understanding Earnings Quality

Abstract

The central goal of this article is to provide nonprofessional investors with an understanding of the impact of accrual accounting on earnings quality. Improving nonprofessional investors’ understanding of earnings quality is essential to the capital market, as they have been found to own nearly one-third of all outstanding stock (Bogle, 2005), a number which anecdotally has increased with the advent of employerdirected compensation plans and online stock trading platforms. Following a presentation of the importance of accruals in the earnings process, the framework discusses various earnings management practices that nonprofessional investors should consider when evaluating earnings quality.