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Actg 431 Week 3

The document discusses the qualitative characteristics of financial statements including relevance, faithful representation, materiality, predictive value, confirmatory value, completeness, neutrality, freedom from error, comparability, consistency, understandability, verifiability, and timeliness. It also discusses the cost constraint on useful financial reporting.

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Kimberly Zafra
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29 views3 pages

Actg 431 Week 3

The document discusses the qualitative characteristics of financial statements including relevance, faithful representation, materiality, predictive value, confirmatory value, completeness, neutrality, freedom from error, comparability, consistency, understandability, verifiability, and timeliness. It also discusses the cost constraint on useful financial reporting.

Uploaded by

Kimberly Zafra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

Qualitative characteristics of financial statements are the attributes that make the information
in financial statements useful to investors, creditors and others. The Conceptual Framework
identifies two types qualitative characteristics:
a. Fundamental Qualitative Characteristics
b. Enhancing Qualitative Characteristics

FUNDAMENTAL QUALITATIVE CHARACTERISTICS

The Conceptual Framework enumerates two fundamental qualitative characteristics of useful


financial information: (1) relevance and (2) faithful representation.

Relevance. Information in financial statements is relevant when it influences the economic


decisions of users. It can do that both by (a) helping them evaluate past, present, or future events
relating to an entity and by (b) confirming or correcting past evaluations they have made.

Materiality. The relevance of information is affected by its nature and 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. In other words, materiality is an entity-
specific aspect of relevance based on the nature or magnitude, or both, of the items to which
the information relates in the context of an individual entity’s financial report.

The Conceptual Framework does not specify a uniform quantitative threshold for
materiality or predetermine what could be material in a particular situation. Very often,
this is dependent on good judgment, professional expertise and common sense. In the
exercise of judgment, the relative size and nature of an item are considered.

Ingredients of relevance:

 Predictive Value. Information can help users increase the likelihood of correctly predicting
or forecasting the outcome of certain events.

 Confirmatory Value. Information can help users confirm or correct earlier expectations.

Note that the predictive and confirmatory roles of information are interrelated.

Faithful Representation. Financial reports represent economic phenomena in words and


numbers. To be useful, financial information must not only represent relevant phenomena, but it
must also faithfully represent the phenomena that it purports to represent. To be a perfectly faithful
representation, a depiction would have three characteristics. It would be complete, neutral and
free from error.

Factors of Faithful Representation

 Completeness. The information in the financial statements must be complete within the
bounds of materiality and cost. Completeness is the result of adequate disclosure
standard or the principle of full disclosure.
 Neutrality. Information contained in the financial statements must be free from bias and
error.

 Free from error means there are no errors or omissions in the description of the
phenomenon, and the process used to produce the reported information has been
selected and applied with no errors in the process.

What about Substance over Form?

Substance over form is not considered as a separate component of faithful representation


because it would be redundant. Faithful representation inherently represents the substance
of an economic phenomenon or transaction rather than merely representing the legal form.

Conservatism means the inclusion of a degree of caution in the exercise of judgments needed
in making estimates or choosing alternatives so that the outcome will have the least effect on
equity. Prudence is the desire to exercise care and caution when dealing with the uncertainties
in the measurement process such that assets or income are not overstated and liabilities or
expenses are not understated.

The Conceptual Framework, however, did not include conservatism or prudence as an


aspect of faithful representation because to do so would be inconsistent with neutrality.
Most often, a conservatism approach is subjective and may contain an element of bias.

ENHANCING QUALITATIVE CHARACTERISTICS

The Conceptual Framework provides the following enhancing qualitative characteristics of


financial information:

Comparability. Users must be able to compare the financial statements of an entity over time
so that they can identify trends in its financial position and performance. Users must also be able
to compare the financial statements of different entities. Disclosure of accounting policies is
essential for comparability especially when the entity adopts a new or changes its accounting
policies.

Consistency. The same method for the same item must be used either from period to period
within an entity or in a single period across entities.

Understandability. Information should be presented in a way that is readily understandable by


users who have a reasonable knowledge of business and economic activities and accounting and
who are willing to study the information diligently.

Verifiability. The financial information is verifiable when it is supported, directly or indirectly, by


evidence so that an accountant that would look into the same evidence would arrive at the same
economic decision or conclusion.

Timeliness. Undue delay in reporting of information may lead to the loss of relevance even
though enhancing it reliability. While providing information before all aspects of a transaction or
other events are known may increase the relevance of information, thus impairing its reliability.
THE COST CONSTRAINT ON USEFUL FINANCIAL REPORTING

The benefits derived from the information should exceed the cost incurred in obtaining it.

- - END - -

Source:
1. Financial Accounting Vol.I, First Part, 2016 Edition Valix, Conrado T., Peralta, Jose F. and
Valix, Christian Aris M.
2. The Conceptual Framework for Financial Reporting, IFRS Foundation

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