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Qualitative characteristics of useful financial information (Enhancing…
Qualitative characteristics of useful financial information
The Conceptual Framework has a series of concepts which are important to financial reporting and these are divided into fundamental qualitative concepts and enhancing qualitative concepts
Fundamental qualitative concepts
Relevance
Faithful representation
Enhancing qualitative characteristics
Verifiability
Comparability
Timeliness
Understandability
If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent.
Stakeholders require financial statements to be relevant to the decisions they have to make. In determining what is relevant to users, preparers of accounts should consider whether information is material and the extent to whichreliable information may be omitted. Information may be relevant simply because of its magnitude or because its omission from the financial statements could affect decision making.
Financial information is capable of making a difference in decision making if it has predictive value, confirmatory value or both. Predictive value and confirmatory value are interrelated in that the same information can do both
The issue of faithful representation is related to the idea of ‘substance over form’; to portray a true economic position, it may be necessary to override
the legal form of a transaction. Without the concept of substance over form, accounts could be very misleading in terms of the real economic situation of the entity.
Faithful representation requires information to meet three criteria
Complete: all information that users need to understand the item is given
Neutral There is no bias in the selection or presentation of information
There are no omissions and no errors in the process to produce the information, although this does not mean the information is necessarily completely accurate as it contains many estimates
There is some controversy over the fact that the IASB has removed prudence as a fundamental concept, although the Framework does state that prudence supports neutrality by ensuring that assets and income are not overstated and liabilities and expenses are not understated.
Comparability
Means that financial statements should be comparable with prior year financial statements and with financial statements of similar entities in the same industry sector to enable users of financial statements to make informed decisions.
If financial statements lack this attribute, analysts will be less equipped to assess trends and financial ratios. Not all financial statements will be easily comparable but the basic accounting concepts and policies employed often coalesce around industry norms.
This enables users to see and evaluate differences within any one reporting period or over several reporting periods, whether comparing an entity’s own figures over time or benchmarking against similar businesses in the same industry sector. If a reporting entity considers it
is justified in changing an accounting policy from one year to the next then it should ensure that the prior year’s figures are restated to enable users to have a like-for-like prior year comparative when assessing performance and changes in the financial position.
Verifiability
Enables different knowledgeable and independent observers to reach consensus on the treatment of an item, although complete agreement is unlikely ever to be possible.
Verifiability is not the same as being auditable, i.e. capable of being subject to audit checking, but it has similarities in the sense that if something is not verifiable, it is unlikely to be auditable and hence its reliability and usefulness is diminished.
Timeliness
Is important as information needs to be timely to be capable of influencing the decisions of users of the accounts. Information may lose its relevance if it is not reported in a timely manner. The older the information is, the less likely it is to influence decision-making by users.
Understandability
Very important as financial statements can be so complex that even accountants and other users with a good knowledge of accounts struggle to understand them
Some financial transactions, however, are inherently complex and difficult to understand, but to omit such information would not give a fair representation of the financial statements. It is therefore important that the format and layout of the financial statements, the accounting policies applied, the terminology used and other statements made within the financial statements are clear and concise.
All material information should be complete and presented in a way that ensures users can understand the entity’s results.
The Framework also states that there is a pervasive constraint on the information that can be provided by financial reporting, which is cost, i.e. costs need to be justified by the benefits of reporting the information. Most would interpret cost here as the cost to the entity of providing the information; however the IASB makes clear in the Framework that the entity must also consider the cost to the user of finding necessary information if the entity itself does not provide it.