Top 11 Qualitative Characteristics of Accounting Information

Conversely, the company might report useful financial information that creditors aren’t interested in like employee salaries. Creditors are more concerned about cash flow and profitability—not smaller operational details. Out of date information does not do investors or creditors any good when they are trying to make current and future decisions. Financial reporting must be timely and current in order to be used by investors and creditors. However, the company suffering a causality loss because the factory burned down to the ground is a relevant piece of accounting information.

Relevance in Accounting for Whom?

According to Backer, “different accounting methods are needed to reflect different management objectives and circumstances. Thus, consistency and uniformity in accounting methods would not necessarily bring comparability. Consistency of method over a period of time is a valuable quality that makes accounting numbers more useful.

It is important and relevant information for the investors in making their decision as growing earnings provide a good return for the investors. It is why the relevance principle is of prime importance to financial accounting. However, if the amount of default is, say, $2 million, the information becomes relevant to the users as it may affect their view regarding the financial performance and position of the company. Relevance considers the importance of the information for your research needs. In fact, all aspects of evaluation must be taken into consideration to determine relevance. Financial statements are important to investors because they can provide enormous information about a company’s revenue, expenses, profitability, debt load, and the ability to meet its short-term and long-term financial obligations.

• Of course, in some situations, the nature of some items of information may dictate their materiality regardless of their relative size or the fact that they cannot be adequately quantified.
• It follows that relevant information must be reported Relevance has been defined in accounting literature, but no satisfactory set of relevant items of information has been suggested.
• Reliable information is required to form judgements about the earning potential and financial position of a business firm.
• Reliability refers to undistorted complete information that is free from errors.

To be considered relevant, information must possess either predictive value, helping in forming expectations about future events, or confirmatory value, acting as feedback that corrects or reinforces prior judgments. There is a place for a convention, such as conservatism—meaning prudence, in financial accounting and reporting, because business and economic activities are surrounded by uncertainty, but it needs to be applied with care. Conservatism in financial reporting should no longer connote deliberate, consistent, understatement of net assets and profits. Some reports need to be prepared quickly, say in case of takeover bid or strike. In some other contexts, such as routine reports by a business firm of its annual results, a longer delay in reporting information may materially affect the relevance and, therefore, the usefulness of information. But in order to have gain in relevance that comes with increased timeliness, it may involve sacrifices of other desirable characteristics of information, and as a result there may be an overall gain or loss in usefulness.

The above mentioned characteristics (relevance, materiality, understandability, comparability, consistency, reliability, neutrality, timeliness, economic realism) make financial reporting information useful to users. These normative qualities of information are based largely upon the common needs of users. That is, accounting information should not be limited to the interests of the average investor or sophisticated users but, in fact, information should be ordered and arrayed to serve a broad range of users. Many stakeholders also use past financial statements to analyze the company’s future performance regarding profitability. Therefore any such false data doesn’t come under the definition of accounting relevance.

What does reliability mean in accounting?

Obviously financial information that isn’t related to users decisions isn’t useful to creditors or investors. That is why FASB committed to making financial reporting relevant to the end users. Users’ needs may change over time which would require a change in accounting principles, standards and methods. These improvements are needed to serve users’ needs in changing circumstances. When it is found that current practices or presentations being followed are not fulfilling users’ purposes, a new practice or procedure should be adopted.

Best Practices for Producing Relevant Accounting Information

Further, the costs that will remain the same with or without replacing the equipment are not relevant. Examples are the depreciation of the building, salaries of the company’s management, etc. Finally, it can be concluded that there are likely to be trade-offs between qualitative characteristics in many circumstances. The concept of materiality permeates the entire field of accounting and auditing.

The financial information must be timely to be relevant to the investors. Under revaluation method, fixed assets are revalued as often as required to bring their balance sheet value close enough to their market value. This should result in more relevant information because users will be able to better assess the value of potential benefits from the use or sale of fixed assets (Predictive Value). From the auditors’ perspective, the financial statement that they need to audit is the balance sheet (Also see How to Ensure Your Company’s Audit Process Goes Smoothly?), so the balance sheet is the most important to them. That is why the relevance principle is so important to financial accounting.

While every loss of reliability diminishes the usefulness of information, it will often be possible to approximate an accounting number to make it available more quickly without making it materially unreliable. If relevance in accounting assets are valued at cost in some periods, and at replacement cost in others, the firm’s earning power may be distorted, especially when the difference in cost and replacement cost is significant over a period of time. Information, if comparable, will assist the decision-maker to determine relative financial strengths and weaknesses and prospects for the future, between two or more firms or between periods in a single firm. It is hardly ever a question of black or white, but rather of more reliability or less. Reliability rests upon the extent to which the accounting description or measurement is verifiable and representationally faithful. Neutrality of information also interacts with those two components of reliability to affect the usefulness of the information.

For example, information regarding plant and machinery may be less reliable than certain information about current assets because of differences in uncertainty of realisation. Reliability is that quality which permits users of data to depend upon it with confidence as representative of what it purports to represent. Information is relevant if it helps users of the financial statements in predicting future trends of the business (Predictive Value) or confirming or correcting any past predictions they have made (Confirmatory Value). Same piece of information which assists users in confirming their past predictions may also be helpful in forming future forecasts.

Thank you for diving into our detailed explanation and tackling these insightful quiz questions. Remember, relevance is key in both accurate financial reporting and prudent decision-making within any organization. However, in another study conducted by FASB (USA) to know the participants’ views about the importance of the qualitative characteristics of financial statement data, the following ranking were obtained. The definitional problem arises from cash vs., accrual accounting, or the principle of matching costs with revenues.

A company discloses an increase in Earnings Per Share (EPS) from $5 to $6 since the last reporting period. The information is relevant to investors as it may assist them in confirming their past predictions regarding the profitability of the company and will also help them in forecasting future trend in the earnings of the company. Information is relevant if either it can be used as input in processes used to identify future outcomes (i.e. it has predictive value) or it can confirm past evaluations about economic phenomenon (i.e. it has confirmatory value) or both.

Top 11 Qualitative Characteristics of Accounting Information

Completeness means disclosure of all information necessary for proper understanding of the underlying phenomena. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. If it were otherwise, the information would be valueless—by definition, irrelevant and—the effort to produce it would be futile.

Relevance refers to the property of information being capable of making a difference in decisions made by users of that information. Faithful representation refers to an information’s ability to represent underlying economic phenomena faithfully. Predictive value refers to the fact that quality financial information can be used to base predictions, forecasts, and projections on. Financial annalists and investors can use past financial statements to chart performance trends and make predictions about future performance and profitability. Generally, the decision-makers (investor, accountant and manager) see materiality in relation to actual assets or income. Investors see materiality in terms of the rate of change or change in the rate of change.