Qualitative Characteristics of Useful Financial Information

Topics: Decision making, Risk, Balance sheet Pages: 5 (1074 words) Published: November 16, 2012
Qualitative Characteristics of Useful Financial Information

The purpose of financial reporting is to provide decision makers with useful information. When accounting choices are to be made by individuals, those choices should be based upon the usefulness of that information to the decision making process. The Framework identifies six qualitative characteristics of financial statements as follows:-

relevance;
faithful representation;
comparability;
verifiability;
timeliness; and
understandability.

The first two characteristics are fundamental characteristics; and the latter four are enhancing characteristics, which are complimentary to the fundamental characteristics.

1Fundamental Characteristics – Relevance

To be relevant, accounting information must be capable of making a difference in a decision. Information with no bearing on a decision is irrelevant. Financial information is capable of making a difference when it has predictive value, confirmatory value, or both.

Financial information has predictive value if it has value as input to predictive processes used by investors to form their own expectations about the future. For example, if potential investors are interested in purchasing shares in RSB, they may analyse its current resources and claims to those resources, its dividend payments, and its past performance to predict the amount, timing and uncertainty of RSB’s future cash flows.

Relevant information also helps users confirming or correcting past evaluations they have made (confirmative value). For example, when RSB issues its year-end financial statements, it confirms or changes past (or present) expectations based on previous evaluations. The predictive and confirmatory roles of information are interrelated. For example, information about the current level and structure of RSB’s assets and liabilities helps users in predicting its ability to take advantage of opportunities and react to adverse situations. The same information helps confirming or correcting users’ past predictions about that ability.


2Fundamental Characteristics – Faithful Representation

Faithful representation means that the numbers and descriptions match what really existed or happened. For example, if RSB’s statement of comprehensive income reports sales of RM500 million when it had sales of RM300 million, then the statement fails to faithfully represent the proper sales amount. To be a faithful representation, information must be complete, neutral, and free of material error.

(a)Completeness

Completeness means that all information that is necessary for faithful representation is provided. An omission can cause information to be false or misleading and thus not be helpful to the users of financial statements. For example, when Citigroup fails to provide information needed to assess the value of its subprime loan receivables, the information is not complete and therefore is not faithfully represent their values.

(b)Neutrality

Neutrality means that a company cannot select information to favour one set of interested parties over another. Financial statements are not neutral if, by the selection or presentation of information, they influence the making of a decision or judgement in order to achieve a predetermined result or outcome. For example, in the notes to financial statements, tobacco companies such as KT&G Corporation should not suppress information about the numerous lawsuits that have been filed because of tobacco-related health concerns – even though such disclosure is damaging to the company.

(c)Free from error

An information item that is free from error will be a more accurate representation of a financial item. For example, if UBS misstates its loan losses, its financial statements are misleading and not a faithful representation of its financial results. However, it should be noted that faithful representation does not imply total freedom from error. This is...
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