Financial reporting
The primary objective of financial reporting is to provide useful information for making business decisions.
Useful accounting information should possess two fundamental qualitative characteristics:
- Relevance
Relevance means that the information can influence the economic decisions made by users. For example, the information may help users to predict future events, such as future cash flows, and help determine alternative courses of action under consideration. Information is also relevant if it is able to help decision makers evaluate past decisions. Thus, information that is relevant is said to have a predictive role and a confirmatory or feedback role. - Reliability
Reliability means that the user is assured that the information presented represents faithfully, without bias, the transactions and events being reported. This is a major reason that accountants record assets at their original historical cost. For accountants to record current market values requires the use of estimates, appraisals or opinions, all of which are more unreliable.
Additionally, there are enhancing qualities.
- Timeliness
For accounting information to be relevant, it must be timely, i.e. it must be available to the decision makers before it loses its capacity to appropriately inform decisions. - Comparability
Comparability results when different companies use the same accounting principles. - Materiality
It is important that users are not overwhelmed with so much detail that they cannot clearly understand the message. The concept of materiality relates to the extent to which information can be omitted, misstated or grouped with other information without misleading the statement users when they are making their economic decisions. - Verifiability
Information is verifiable if independent observers, using the same methods, obtain similar results. - Consistency
A company uses the same accounting principles and methods from year to year. - Understandability
When information is included in general purpose financial reports, there is an obvious need for the users of those reports to be able to comprehend their meaning.
Test your knowledge
There are some qualities of accounting that make it useful for both external and internal users of accounting. Without these qualities accounting information wouldn’t be clear and an orderly view of the business would not be visible. 4 qualitative characteristics of accounting information are;
Comparability
Comparison is a very important part of financial information as it helps the users of accounting information to differentiate, analyze, improve, and take important decisions.
The ability to do intra-firm comparison (within the same company), inter-firm comparison (with other companies), and market sector comparison (comparison within the same market sector) makes accounting information easy to work with.
Example of Comparability – QoQ (Quarter on Quarter) & YoY (Year on Year comparisons) should be possible with the accounting information.
Understandability
The presentation of accounting information should be simple and understandable for the users of the information. It is important that all the data is clear and concise, it can be easily understood by everyone including parties who are not from the accounting background.
All relevant explanatory notes should be provided along with the financial statements. Method of valuation of inventory, method of depreciation, information on reserves and surplus, contingent liabilities, and any other extraordinary items.
Example of Understandability – It should be possible for bankers, investors, employees, etc. to understand financial information of the business.
Reliability
One of the most important among qualitative characteristics of accounting information is reliability of data, i.e. all information provided must be traceable and verifiable with proper source documents.
In case of an internal or an external audit the information inside financial statements should be confirmable back to its original source. Failure of an audit may lead to disbelief in the company’s financial data.
Example of Reliability – An auditor must be able to verify a transaction back to its origin with the help of invoices, memos, purchase order, sales order, etc.
Relevance
Relevance of accounting information means it should help the user of information with their decision making process. The information provided should not be irrelevant and unnecessary. All information should be capable of monetary computation.
Example of Relevance – A firm is expected to provide the total amount owed by the debtors in the balance sheet, whereas the total number of debtors is not important.