Qualitative Characteristics Of Financial Information Essay

Question:

Discuss about the Qualitative Characteristics of Financial Information.

Answer:

Introduction

Financial Information is the set of raw accounting data of an entity which is presented in an organised form in the general purpose financial statements. The financial information is used for the financial reporting purposes by an entity hence it must possess the basic qualitative characteristics as prescribed by the Australian Accounting Standard Board in SAC 3, Qualitative Characteristics of Financial Statements. This standard on accounting concepts sets out all the key characteristics of financial information. The basic characteristics of financial information are classified on the basis of two criteria i.e. selection criteria and presentation criteria. On the basis of selection criteria the information must be characterised as relevant and reliable and on the basis of presentation criteria the financial information must be comparable and understandable.

Qualitative Characteristics of Financial Information

Characteristics on the basis of selection of financial information:

Under this set of criteria relevance and reliability are considered as the basic qualitative characteristics required by financial information to be possessed in order to be competent for the financial reporting requirements (FASB, 2010). Relevance and reliability are equally important and therefore can be ranked before one another.

Relevance

Information to be considered as relevant must be capable of influencing the user’s decisions. To influence the decision making process of the readers the financial information play two important roles that are the predictive and conformity role (Australian Government, 2001).

The predictive value of an information is defined as the ability of financial information contained in general purpose financial statements, to enable the users to make predictions and estimations about the future situation of the concerned company (Jones & Smith, 2011). To possess the attribute of predictive value the financial information is not necessarily required to be in explicit forecast form. For example, the reported earnings in the financial statement to have a predictive value must enable the users to predict the level of future earnings of the company (Birt, Muthusamy & Bir, 2017). Another example to illustrate the predictive value of financial information can be taken from the current level of asset holdings of the company which will be considered of value if it makes the users able to predict the company’s capability to assess the future opportunities in the market. Confirmatory value of information will enable the readers to verify and confirm the past evaluations (Hodge, Hopkins & Wood, 2010).

Reliability

Reliability of information will be achieved when the information is free from any undue error or the biasness and thus representing the true picture of all the transactions and other business situations in a faithful manner. The degree of how reliable an information is determined by the correspondence between the real business transactions and events and the actual presentation in the financial statements. The reliable information would be accurate enough to represent the true and fair picture of underlying events and transactions.

While incorporating the financial information in the financial reports the degree of relevance and reliability of information has to be balances as the reliability of information would not make any difference if the information is irrelevant. On the opposite side, no matter how much relevance an information holds if it is not reliable (Rankin, et al., 2012).

Materiality test: Once the information is identified as relevant and reliable it must be tested for its materiality level. Materiality of the information is defined as the significance of the information in the overall decision making process of an entity. If immaterial information is incorporated in the financial reports it will distort the quality of information content as a whole and will also contribute to disturb the basic element of understanding of the financial information. The materiality of any information can be assessed either on the basis of size of the information or on the nature of information. The test of materiality is important because an information which is of relevance and is reliable in its general nature but not material in the given circumstances for which the information is prepared and presented.

Characteristics on the basis of selection of financial information:

Comparability

The comparability feature of information makes it comparable with the other relevant information whether from the same company or from another company in the same industry for the analytical procedures (Franco, Kothari & Verdi, 2011). For example, the users may make comparisons of company’s current financial position with the previous years’ results or with the financial performance of other company’s whose performance is considered as the benchmark in the industry. For an information attributes of relevance and reliability are not sufficient at a particular point of time or in a specific circumstance or for a specific company (Kober, Lee & Ng, 2010). The information must be comparable with the information of the other times or another entities. In order to achieve the purpose of comparability, the consistency of information between the different reporting periods and reporting entities is required to be maintained.

Comparability of the financial information must not be construed as mere consistency as it would not be acceptable for the entities to report a matter or a transaction in the same manner as is adopted by the other entities if such consistency policy is not in line with the relevance and reliability values of the information (Collier, 2015).

Understandable

The accounting information contained in the financial statements must be easily understandable to the users provided they possess the requisite knowledge and idea of company’s economic activities. Information must be presented in the clear and concise manner so as to provide the users with an ease to understand the true scenario of company’s financial statements (Halabi, Barrett & Dyt, 2010). However, the preparers should not ignore the incorporation of items which are complex by their very nature merely to make the financial reports simplified and understandable. Rather the information must be prepared and presented keeping in mind that the users can take expert advice on the matters that are complex by nature. The attribute of understanding must be achieved by the company without having the need to compromise with the prime qualities of relevance and reliability of financial information contained in the general purpose financial statements.

Conclusion

Financial statements of an entity serve various purposes like for financial reporting requirements, compliance of regulations from various regulatory bodies, loan sanctioning from financial institutions and banks. Therefore, the information contained in the financial reports has to be relevant and reliable so that it can influence the decision of readers. If the preparers of the information neglects the importance of the qualitative characteristics of the information, the information will lose its value in the eyes of users. Besides the key qualitative characteristics, timeliness of the information has to be given due importance. An information provided on time only can have its value for the users in their decision making otherwise it is of no use or relevance. Therefore to provide the best outcomes of the reports the information content must possess all the above discussed attributes.

Reference List

Australian Government, 2001. Qualitative Characteristics of financial information: SAC 3, available at (viewed on 21th September, 2017)

Birt, J.L., Muthusamy, K. and Bir, P., 2017. XBRL and the Qualitative Characteristics of Useful Financial Information. Accounting Research Journal, 30(1).

Collier, P.M., 2015. Accounting for managers: Interpreting accounting information for decision making. John Wiley & Sons.

De Franco, G., Kothari, S.P. and Verdi, R.S., 2011. The benefits of financial statement comparability. Journal of Accounting Research, 49(4), pp.895-931.

Financial Accounting Standards Board (FASB), 2010. Conceptual Framework for Financial Reporting: Chapter 1, The Objective of General Purpose Financial Reporting, and Chapter 3, Qualitative Characteristics of Useful Financial Information. Statement of Financial Accounting Concept No. 8.

Halabi, A.K., Barrett, R. and Dyt, R., 2010. Understanding financial information used to assess small firm performance: An Australian qualitative study. Qualitative Research in Accounting & Management, 7(2), pp.163-179.

Hodge, F.D., Hopkins, P.E. and Wood, D.A., 2010. The effects of financial statement information proximity and feedback on cash flow forecasts. Contemporary Accounting Research, 27(1), pp.101-133.

Jones, D.A. and Smith, K.J., 2011. Comparing the value relevance, predictive value, and persistence of other comprehensive income and special items. The Accounting Review, 86(6), pp.2047-2073.

Kober, R., Lee, J. and Ng, J., 2010. Mind your accruals: perceived usefulness of financial information in the Australian public sector under different accounting systems. Financial Accountability & Management, 26(3), pp.267-298.

Rankin, M., Stanton, P.A., McGowan, S.C., Ferlauto, K. and Tilling, M., 2012. Contemporary issues in accounting. Milton, Australia: Wiley.

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