Gains and losses from the sale of investments can affect earnings quality because:

• A. they are always included in the calculation of gross profit.
• B. they may not reflect the company's core operating performance.
• C. they are classified as cash flows from operating activities.
• D. they are recognized only when investments are purchased.

Answer: (B)

Verified step by step guidance

1. Understand the concept of earnings quality: Earnings quality refers to the ability of reported earnings to reflect the company's true financial performance and predict future earnings. Gains and losses from the sale of investments can impact this quality.
2. Analyze the nature of gains and losses from investments: These gains and losses are typically non-recurring and may not be directly related to the company's core operating activities, which focus on generating revenue from its primary business operations.
3. Consider the classification of gains and losses: Gains and losses from the sale of investments are often classified as non-operating items in the income statement, meaning they do not contribute to gross profit or reflect the company's core operating performance.
4. Evaluate the impact on cash flow classification: While these gains and losses may affect net income, they are generally classified as cash flows from investing activities, not operating activities, in the statement of cash flows.
5. Conclude why they may not reflect core operating performance: Since these gains and losses arise from investment activities rather than the company's primary operations, they may distort the perception of the company's earnings quality and core business performance.