Which of the fundamental and enhancing qualitative characteristics do you regard as most important for the preparers of financial statements and why?
|
For financial information to be of any use to investors, creditors, and other stakeholders, it must exhibit certain required and desired attributes. These attributes are called qualitative characteristics of useful financial information. Show
The IASB and FASB have identified these characteristics in their conceptual frameworks because these guide their standard-setting process. Qualitative characteristics of useful financial information are categorized into fundamental qualitative characteristics and enhancing qualitative characteristics. Fundamental qualitative characteristicsFundamental qualitative characteristics are those whose absence makes financial information no longer useful. Relevance and faithful representation are the fundamental qualitative characteristics. Relevance gives financial information the capability of making a difference in decisions made by users. Such capability arises when the information has either predictive value, confirmatory value, or both. Relevance is applicable in the context of materiality. Materiality is the quality of financial information which makes its omission or misstatement significant enough to impact the decisions that users make through reliance on the information. Materiality acts as a filter on relevant information such that relevant information is useful only when it is material. Faithful representation is achieved when financial information truthfully represents the underlying economics of a phenomena. This is achieved when information is complete, neutral (without any understatement or overstatement bias) and free from error (at least in the process used to produce the information). Enhancing qualitative characteristicsEnhancing qualitative characteristics improve usefulness of financial information. However, neither do they compensate for lack of relevance or faithful presentation nor their absence make the information useless. They help decide between two equally relevant and true and faithful accounting choices for a single transaction. Preparers of financial information must achieve to maximum enhancing qualitative characteristics. Enhancing qualitative characteristics include comparability, verifiability, timeliness and understandability. Comparability requires financial information to be comparable across periods and companies. Comparability is achieved through consistency. Verifiability is the property which enables different knowledgeable users to agree that particular financial information exhibits truthful representation. It improves usefulness of financial statements because it assures users that they are indeed true and fair. Timeliness is achieved when financial information is made available early enough for it to impact decisions made by the users. Understandability requires financial information to be classified, characterized and presented such that it can be understood by users with reasonable knowledge of business and economic activities. by Obaidullah Jan, ACA, CFA and last modified on Oct 30, 2020 The fundamental (primary) and enhancing (secondary) qualitative characteristics What are the Qualitative Characteristics of Accounting Information?The demand for accounting information by investors, lenders, creditors, etc., creates fundamental qualitative characteristics that are desirable in accounting information. There are six qualitative characteristics of accounting information. Two of the six qualitative characteristics are fundamental (must have), while the remaining four qualitative characteristics are enhancing (nice to have). Fundamental (Primary) Qualitative CharacteristicsQualitative characteristics of accounting information that must be present for information to be useful in making decisions:
Enhancing (Secondary) Qualitative CharacteristicsQualitative characteristics of accounting information that impact how useful the information is:
We will look at each qualitative characteristic in more detail below. RelevanceRelevance refers to how helpful the information is for financial decision-making processes. For accounting information to be relevant, it must possess:
Therefore, accounting information is relevant if it can provide helpful information about past events and help in predicting future events or in taking action to deal with possible future events. For example, a company experiencing a strong quarter and presenting these improved results to creditors is relevant to the creditors’ decision-making process to extend or enlarge credit available to the company. Representational FaithfulnessRepresentational faithfulness, also known as reliability, is the extent to which information accurately reflects a company’s resources, obligatory claims, transactions, etc. To help, think of a pictorial depiction of something in real life – how accurately does the picture represent what you see in real life? For accounting information to possess representational faithfulness, it must be:
VerifiabilityVerifiability is the extent to which information is reproducible given the same data and assumptions. For example, if a company owns equipment worth $1,000 and told an accountant the purchase cost, salvage value, depreciation method, and useful life, the accountant should be able to reproduce the same result. If they cannot, the information is considered not verifiable. TimelinessTimeliness is how quickly information is available to users of accounting information. The less timely (thus resulting in older information), the less useful information is for decision-making. Timeliness matters for accounting information because it competes with other information. For example, if a company issues its financial statements a year after its accounting period, users of financial statements would find it difficult to determine how well the company is doing in the present. UnderstandabilityUnderstandability is the degree to which information is easily understood. In today’s society, corporate annual reports are in excess of 100 pages, with significant qualitative information. Information that is understandable to the average user of financial statements is highly desirable. It is common for poorly performing companies to use a lot of jargon and difficult phrasing in its annual report in an attempt to disguise the underperformance. ComparabilityComparability is the degree to which accounting standards and policies are consistently applied from one period to another. Financial statements that are comparable, with consistent accounting standards and policies applied throughout each accounting period, enable users to draw insightful conclusions about the trends and performance of the company over time. In addition, comparability also refers to the ability to easily compare a company’s financial statements with those of other companies. The qualitative characteristics of accounting information are important because they make it easier for both company management and investors to utilize a company’s financial statements to make well-informed decisions. More ResourcesThank you for reading CFI’s guide on Qualitative Characteristics of Accounting Information. To keep learning and advancing your career, the following resources will be helpful:
What are the fundamental and enhancing qualitative characteristics of financial information?The two fundamental qualitative characteristics of financial reports are relevance and faithful representation. The four enhancing qualitative characteristics are comparability, verifiability, timeliness and understandability.
What is the most important qualitative characteristics of accounting information?Reliability. One of the most important qualitative characteristics of accounting information is the reliability of data, i.e. all information provided must be traceable and verifiable with proper source documents.
What are the fundamental characteristics of financial statements?Actually there are four qualitative characteristics of financial statements. The four characteristics are understandability, relevance, reliability, and comparability.
Which qualitative characteristics relate to the presentation of financial statements?Qualitative characteristics are the attributes that make the information provided in financial statements useful to users. The four principal qualitative characteristics are understandability, relevance, reliability and comparability.
|
