Decision Usefulness Approach
Can the decision usefulness approach make financial reporting more useful?
This paper explores the question whether the financial statements can be made more useful. This leads to an important concept in accounting-- the concept of decision usefulness. To properly understand this concept, this paper outlines other theories from economics and finance to assist in conceptualizing the meaning of useful financial statement information. The main purpose of this paper is to introduce the concept of decision usefulness approach, related theories, and its applications in practice. It points out that accountants cannot proceed to make financial statements more useful until they know what usefulness means. As getting more understanding of the usefulness of information, it concludes that the decision usefulness approach leads firms to make financial statement more useful to their users.
Table of Contents
The Concept of Decision Usefulness 3
Who are the users of financial statements? 4
What are the objectives to provide useful financial statements to users?6
What are the decision problems of financial statement user? 7
The Application of Decision Usefulness Approach8
The reaction of professional accounting bodies to the decision usefulness approach8 Conflicts of incongruent goals 9
Reality of using decision usefulness approach to financial reporting9 Conclusions 10
Can the decision usefulness approach make financial reporting be more useful?
A decision usefulness approach underlies Section 1000 of the CICA Handbook, and the Conceptual Framework of the FASB in the United States. The essence of this approach is that investors should be supplied with information to help them make good investment decisions. One has only to compare the current annual report of a public company with those issued in the 1960s and prior to see the tremendous increase in disclosure over the 40 years or so since decision usefulness formally became an important concept in accounting theory. Yet, this increase in disclosure did not “just happen.” It is based on fundamental research into the decision theory and the concept of rational investor, which has guided the accountant in what information is useful. Furthermore, the approach has been subjected to extensive empirical testing, which has established that, on average, investors use financial accounting information much as the theory predicts.
The Concept of Decision Usefulness
The decision usefulness approach is an approach to the preparation of financial accounting information that studies the theory of investor decision making in order to infer the nature and types of information that investors need.
The decision usefulness approach to accounting theory takes the view that “if we can’t prepare theoretically correct financial statements, at least we can try to make financial statements more useful.” First stated in 1966, a reinforced by the influential 1973 report of the Trueblood Commission, this simple observation has had major implications for accounting theory and practice. In particular, we must pay more attention to financial statement users and their decision needs, since under non-ideal conditions it is not possible to read the value of the firm directly from the financial statements. Accountants have adopted a decision usefulness approach to financial reporting as a reaction to the impossibility of preparing theoretically correct financial statements. However, the decision usefulness approach leads to the problem of identifying the users of financial statements and information they need to make good decision. Accountants have decided that investors are major constituency of users and have turned to various...
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