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Qualitative Aspects of Financial Reporting |
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1.
Understandability The characteristics better defined as qualities that
should be possessed by financial reports in order that they meet the
needs of the users could be classified into user specific qualities and
primary decision specific qualities.
User Specific Qualities.
(a) Decision Makers and their Characteristics. The
information requirement of users varies from user to user. So a fine
balance should be kept in disclosing too much information or too little
information. Similarly disclosure of certain information to those who are
already in possession of such information makes little relevance to them.
If the receiver of the same could not understand certain information, it
makes little contribution to the purpose at hand. Primary
Decision Specific Qualities.
(a) Relevance. The information provided should be
logically related to the decision to be made in order that it is relevant.
Information is relevant if it can make a difference to the decision taken
on knowing it. In order that the information provided through financial
reports to be relevant to the various users like shareholders, creditors
and others in making investment and credit decisions, such information
should be capable of making difference in the prediction about the outcome
of past, present and future events or to confirm or correct expectations.
The information, which is relevant for one decision,
may not be relevant for another decision-making. If particular information
is not relevant to a certain decision, then it will be unable to influence
the decision either way. Relevant information reduces the uncertainty
surrounding the predictions made by the decision-maker. The information
itself may not be prediction but when it has predictive value it goes as
an input into the prediction process.
The quality of relevance has two components namely,
feedback value and predictive value.
Feedback value is the quality of the information to
confirm the outcome of the predictions made in the past. Predictive value
means value as input into a predictive process, not value directly as a
prediction. Feedback value and predictive value goes hand in hand. Future
is a continuation of the past. The same information, which gives a
feedback on past activities, will help in predicting the future. Segment
Reporting and Interim Earning Reports are examples of information, which
helps in giving feedback about the past activities of the organization and
also helps in making predictions about the future earnings capacity.
Financial models made on the basis-disclosed information will help in
predicting the future performance of the enterprise.
Timeliness is an ancillary aspect of relevance. The
information should be made available when it is required. Otherwise it
will be irrelevant to the decision to be made. Similarly if the
information is reported a long time after it's happening it may lose the
quality of relevance. Timeliness means making available the information to
the user before it loses its capacity to influence decisions. But
timeliness doesn't make irrelevant information relevant but lack of it
could convert relevant information to be irrelevant. Timeliness could not
be put in a timeframe like a day or week. It depends on the nature of the
information and the decision to which it is to be applied. A fine balance
should be maintained between timeliness and precision. Imprecise
information of a certain degree may be more useful if provided in time
than precise information provided untimely
b) Reliability
Reliability is the quality which assures to the user of
the data that ,it represents what it purports to represent .The ICAI
Framework states in paragraphs 31 and 32 as follows
To be useful information must also be reliable.
Information has the quality of reliability when it is free from material
error and bias and can be depended upon by users to represent faithfully
that which it either purports to represent or could reasonably be expected
to represent.
Information may be relevant but in nature or
representation that its recognition may be potentially misleading. For
example, if the validity and amount of a claim for damages under a legal
action against the enterprise are highly uncertain, it may be
inappropriate for the enterprise to recognize the amount of the claim in
the balance sheet, although it may be appropriate to disclose the amount
and circumstances of the claim.
Accounting information is reliable so far as the
reported information represents the true economic condition of the
business, which it is supposed to present. Reliability of accounting
information arises from the two qualities of representational
faithfulness, verifiability and neutrality.
Representational faithfulness is the agreement of the
description of the phenomenon with the actual phenomenon. In financial
statements the state of affairs or the economic condition of the entity is
supposed to be represented. Representational faithfulness is satisfied
when the financial statements represent the actual state of affairs of the
entity with greater degree of precision .It does not mean cent percent
accuracy of the figures as stated. Estimations, apportionment and human
judgments are always involved in accounting, which may be arbitrary, or
cost considerations may come in the way of attaining cent percent accuracy
of the figures in the financial statements.
The quality of verifiability is to provide a
significant degree of assurance that accounting measures represent what
they purport to represent. The quality of verification helps to reduce
measurer bias. It assures that the reported information represents what it
purports to represent. Verification does not assume that the information
provided is relevant as input to the decision to be made. Verifiability
avoids both measurer bias and measurement bias. Measurer bias could be
avoided by repeated measurement using the same measurement techniques .APB
in its statement no.4 has stated, " Verifiable financial accounting
information provides results that would be substantially duplicated by
independent measures using the same measurement methods. Measurement
methods should also be avoided in the financial information. The method of
measurement should represent what it purports to represent.
Neutrality is the quality that information presented
should be objective or unbiased, in that it should meet all proper user
needs. The provider of the information should not be biased towards the
needs of any one-user group. The reports should be neutral between the
competing needs of various user groups. Neutrality implies that in the
formulation of accounting standards, the relevance of the information to
the users should be the primary consideration than its impact on the
interest of a particular user group(s). The objectives of financial
reporting should be to provide information to the general-purpose users of
such information. Hence accounting facts and practices should be
impartially determined with out any bias.
Neutrality is lost when a particular result is desired
and information is provided to attain that result.
Paragraph 36 of the ICAI Framework reads as
To be reliable, the information contained in financial
statements must be neutral, that is, free from bias. Financial statements
are not neutral if, by the selection or presentation of information, they
influence the making of a decision or judgment in order to achieve a
predetermined result or outcome.
(C) Comparability
The receivers of accounting information use the same for taking
economic decisions. Decisions involve selecting the best available
alternative. The best alternative could be selected only when a
comparative study is possible amongst all the available alternatives.
Financial statements should have the quality of comparability. Comparison
may be done with information about other enterprises or with information
about the same enterprise over a period of time. Quantitative information
is useful only when it could be compared with some benchmark. Comparison
helps to detect and explain similarities and differences in the data
compared.
Paragraph 39 of the ICAI Framework reads
Users must be able to compare the financial statements
of an enterprise through time in order to identify trends in its financial
performance and cash flows. Users must also be able to compare the
financial statements of different enterprises in order to evaluate their
relative financial position, performance and cash flows. Hence, the
measurement and display of the financial effects of like transactions and
other events must be carried out in a consistent throughout an enterprise
and over time for that enterprise and in a consistent way for different
enterprises.
The quality of comparability could be attained only when there is
consistency in the accounting methods, adopted in the reporting of
financial information. Consistency in the principles and methods used in
accounting will enhance the utility of financial statements to users by
facilitating analysis and understanding of comparative accounting data.
The Accounting Principles Board stated in APB Opinion
No.20, Accounting changes that " in the preparation of financial
statements there is a presumption that as accounting principle once
adopted should not be changed in accounting for events and transactions of
similar type. Consistent use of accounting principles from one period to
another enhances the utility of financial statement to users by
facilitating analysis and understanding of comparative accounting
data."
Consistency may mean use of the same accounting procedure
by an entity from period to period or use of same procedures and methods
for related items in a single statement or the use of the same methods and
procedures by different entities. Even though consistency is essential to
maintain comparability of reported accounting information but too much
adherence to the same will act as deterrent to bringing about desirable
changes in accounting and thus hinder the progress of accounting. |
