Qualitative characteristics are the attributes that make financial information useful to users. For Analytical purposes, Qualitative characteristics can be differentiated into Fundamental and Enhancing qualitative characteristics. FUNDAMENTAL QUALITATIVE CHARACTERISTICS Fundamental Characteristics distinguish useful financial reporting information from that is not useful or misleading. The two fundamental Qualitative characteristics are :
Relevance: In accounting, the term relevance means it will make a difference to a decision maker. Relevant information is capable of making a difference in the decisions made by users. It is capable of making a difference in decisions if it has predictive value, confirmatory value , or both. Predictive value helps users in predicting or anticipating future outcomes. Confirmatory value enables users to check and confirm earlier predictions or evaluations. For example, in the decision to replace an equipment that has been used for the past six years, the original cost of the equipment does not have relevance. In other words, the original cost is irrelevant or is not relevant in the decision to replace the equipment. What will have relevance are the future amounts, such as the cost of the new equipment, and the savings that will occur when the old equipment is replaced. Here's another expression of relevance: Costs that will differ among alternatives. Costs that will not differ among alternatives do not have relevance. In order to have relevance, accounting information must be timely. Financial statements issued three weeks after the accounting period ends will have more relevance than financial statements issued several months after the period ends. Having timeliness and relevance may mean sacrificing some precision or reliability. The Relevance of information is affected by its nature and its materiality. Materiality : Information is material if omitting it, or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity. Materiality is an aspect of relevance which is entity-specific. It means that what is material to one entity may not be material to another. It is relative. Information is material if it is significant enough to influence the decision of users. Materiality is affected by the nature and magnitude (or size) of the item. Faithful Representation is the second Fundamental Qualitative Characteristic. Faithful Representation The Financial reports represent economic phenomena in words and numbers. The financial information in the financial reports should represent what it purports to represent. Meaning, it should show what really are present (Example: Position of Assets and Liabilities) and what really happened (Example: Position of Income and expenditure), as the case may be. There are three characteristics of faithful representation: 1. Completeness: Depiction of all necessary information for a user to understand the phenomenon being depicted. It includes all necessary descriptions and explanations (adequate or full disclosure of all necessary information), 2. Neutrality: Depiction is without bias in the selection or presentation of Financial information uust not be manipulated in any way in order to influence the decision of users. (fairness and freedom from bias), We often refer to a term called True and Fair View in Accounting. 3. Free from error: means there are no errors and inaccuracies in the description of the phenomenon and no errors made in the process by which the financial information was produced. (no inaccuracies and omissions). That does not mean no inaccuracies can arise, particularly in case of making estimates. The standards expect that the estimates are made on a realistic basis and not arbitrarily. ENHANCING QUALITATIVE CHARACTERISTICS Enhancing Qualitative Characteristics distinguish more useful information from less useful information. The Enhancing Qualitative Characteristics are divided into 4 attributes.
COMPARABILITY Comparability is the Qualitative characteristic that enables users to identify and understand similarities in and differences among items. Information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about other entities and with similar information about the same entity for another period or date. Comparable information enables comparisons within the entity and across entities. When comparisons are made within the entity, information is compared from one accounting period to another. For example: income is compared for the years 2014, 2015, and 2016. Comparability of information across entities enables analysis of similarities and differences between different companies. Corresponding information for preceding periods should be shown to enable comparison over time. Consistency vs. Comparability Consistency is not the same as Comparability. Consistency refers to the use of the same methods for the same items (Consistency of Treatment) either from period to period within a reporting entity or in a single period across entities. Users must be able to distinguish between different accounting policies in order to be able to make a valid comparison of similar items in the accounts of different entities. VERIFIABILITY A company's accounting results are verifiable when they're reproducible, so that, given the same data and assumptions, an independent accountant can produce the same result the company did. Verifiability helps assure that Information faithfully represents the economic phenomena it purports to represent. It means that different knowledgeable and observers could reach consensus that a particular depiction is a Faithful Representation. Verifiability isn't about determining whether the assumptions a company makes are correct. Rather, it's about determining whether the accounting result the company reaches is appropriate for the data, given the assumptions that have been made. The Financial Accounting Standards Board, which writes the rules for the U.S. accounting profession, says that verifiability provides assurance that "accounting measures represent what they purport to represent." It's not enough for a company to say the answer is "2." It also has to show you the "1 + 1" on the other side of the equation. Verifiability. Verifiability has its own limitations too.
TIMELINESS The timeliness of accounting information refers to the provision of information to users quickly enough for them to take action. Information becomes obsolete and useless if it is not reported within time. Usually the Statute specifies the time for preparation and presentation of Financial reports. UNDERSTANDABILITY Classifying, Characterising presenting information clearly and concisely makes it Understandable. A principle which states that a company's financial information should be presented in such a way that a person with a reasonable knowledge of business and finance, and the willingness to study the information, should be able to comprehend it. This principle is included in the Accounting Standards Board's Statement of Principles. by Shyam Sunder Kasturi Source : ACCA Study Material
As we understand that different users require financial information for assistance in their economic decisions. Entities publish financial statements so that users can get their information needs fulfilled. The dependence of users’ economic decision on financial statements is crucial and if the financial information is not accurate or is not true and fair then users may end up making wrong decisions. Therefore, financial statements need to have certain qualitative characteristics in order to be useful to its users. IASB Framework for Presentation and Preparation of Financial Statements states FOUR principal characteristics as follows:
UnderstandabilityUsers cannot use such financial information that they cannot understand. Problems in understanding may arise due to user’s inabilities or because of the information itself. Definitely entity cannot do anything about users and its upon the user to have at basic level of understanding about financial statements. Also, users are not required to be professional accountants and that is why where we expect to have complex information then its neither fault on part of user nor from the side of the entity preparing financial statements. However, entity can present information in such a manner that it helps in understanding. Also with proper explanation financial statements can be made more understandable. Therefore, entity is required to take reasonable measures in order to make financial statements easy to understand. However, it does not mean that complex information which is also of material nature should be excluded from the financial statements on the basis that it is creating problems in overall understandability of financial statements. RelevanceInformation is considered relevant which adds value to the decision making process by providing the required bits and pieces of past, preset and future times. Through relevant information users can evaluate whether they are moving along the right path i.e. making correct decisions. Information is also said to be relevant when it is capable of confirming or correcting the existing thought process and information. Many students might think that financial statements always relates to past (financial period that have already passed) then how come past information can help us in making decisions? Well to give you a simple example, we all use our experience to decide about something and certainly experience is always what we already know from the past. Same way, past information given in financial statements help us in predicting the financial position and financial performance of the company in upcoming financial periods. So, even past information can be relevant. ReliabilityInformation is reliable when it is dependable and this is possible if it is:
Information may be relevant but this alone does not suffice for reliability as well. Information must be reliable as well as relevant in order to be useful for decision making. There are many other factors that contribute towards the reliability of the financial information. ComparabilityComparability of information refers to its ability to stand useful overtime and against the financial information from other sources. Users cannot evaluate different aspects of entity’s financial position and financial performance if they are unable to compare the financial information of one period with another or financial information of one entity with another entity’s financial information. In order to have comparable information entities prepare there financial statements by following a uniform pattern of presentation which is usually as instructed by the International or Local Accounting Standards and after they adopt a particular style they remain consistent in its application. However, comparability does not require that one stays uniform even if there are other ways to make financial statements even more reliable and relevant. By the above discussion we can observe one fact that all four principal characteristics are interrelated and higher level is achieved in one area at the expense of the other. For example, in order to make financial statements more reliable entity may include such financial information which is complex thus higher level of reliability is achieved at the expense of understandability. It is the responsibility of the management to have an optimum mix of all four important qualitative characteristics of financial statements |
What are the qualitative characteristics of financial statements qualitative characteristics are?
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