Apart from being accurate and true, accounting information must have qualitative characteristics. These characteristics allow the managers, investors, creditors, etc., to interpret the accounting information more precisely and make financial decisions. These features improve the usefulness of accounting information.
What are the Qualitative Characteristics of Accounting?
Qualitative Characteristics of Accounting refer to Relevance and Representational faithfulness as primary. Additionally, Verifiability, Timelineness, Understandability, and Comparability are secondary Characteristics of Accounting. Finally, Quantitative Characteristics of Accounting are related to numbers you can measure, such as revenue, expenses, profit margins, and taxes.
There are six types of qualitative characteristics of accounting: Faithful Representation, Relevance, Timeliness, Comparability, Verifiability, and Understandability. While the first two are primary features that must be taken care of in accounting information, the latter four enhance the data.
When is Accounting Information Considered to be Relevant?
Accounting Information is considered relevant when confirmatory and predictive value is added. These values improve the accuracy of accounting information and make it more relevant. They play an imperative role in financial decision-making.
If the accounting information includes data about past financial events, it has confirmatory value. This is because it confirms the possibility of certain economic occurrences. It should also have data that can help predict future events, which gives the information predictive value.
All the information above helps people (managers, creditors, or investors) to make more accurate financial decisions. Relevance itself refers to something useful. Hence, these values are valid in accounting information.
What is Meant by Comparability When Discussing Financial Accounting Information?
Comparability refers to evaluating financial data from different financial periods. This data includes financial policies, accounting standards, and company trends in different accounting periods. Accounting information provides such data, making it easy for company officials to compare how different financial strategies performed and make better decisions about future strategies.
Comparable data helps track the progress of the company’s financial policies and strategies. Such data can be in cash flow statements, balance sheets, and other financial reports, making comparison easy. It also helps to understand the alternative courses of action and choose the best one.
Comparisons can be made between the financial data of different periods of the same company or with that of a competitor. Such comparisons help us understand the changes that can be made to future financial strategies.
What are Fundamental Qualitative Characteristics in Financial Reporting?
There are six qualitative characteristics of financial reporting or accounting information. Two are considered to be the fundamental or primary characteristics, namely Representational Faithfulness and Relevance. These factors are considered essential to financial reporting and must be present in the information for an effective decision-making process.
As discussed above, Relevance refers to bringing confirmatory and predictive value to accounting information. It makes the information present in the accounting data more relevant for making decisions.
Representation Faithfulness means making the accounting information more reliable. If the data provided in the financial information is reliable, its users will be more confident in making economic decisions.
What are the Enhancing Qualitative Characteristics? How Do These Affect Useful Financial Information?
Out of the six qualitative characteristics of the accounting information, four are considered enhancing factors. These are— Timeliness, Comparability, Verifiability, and Understandability. These are not the primary or fundamental characteristics, but they enhance the information, making it more transparent and efficient for its users.
As an enhancing agent, these characteristics improve the data in the information by adding features other than the fundamental characteristics that give additional benefits. Different groups, like managers, creditors, the public, government, investors, or lenders, require accounting or financial information. The information solves different purposes for these groups. For example, comparability will help investors decide where to invest for better returns. Verifiability will give creditors more confidence in determining how much credit or loan is safer for them to extend to the company.
The enhancing characteristics improve the usefulness of the data and support financial decisions.
What is the Relevance of Accounting Principles?
Accounting Principles are the standard accounting rules that must be followed while preparing a company’s financial statements. According to the FASB, companies must follow these rules to create standardized financial information.
Because of accounting principles, companies cannot prepare financial statements as and how they want them and can only include the information that will benefit them. The accounting principle’s significant Relevance is removing the cheating factor from the company’s financial reports.
What is Meant by Relevance and Faithful Representation?
Relevance and Faithful Representation (Reliability) are two fundamental qualitative characteristics of accounting information. These are essential and work together to make the data more valuable.
Relevance is the first feature to be added to the financial information. By Relevance, we mean adding aspects that solve the purpose for which the reports are being created. In short, it should be relevant to the goal. This can be done by adding the information’s confirmatory (data of past financial events) and predictive (efficiency in predicting future events) values.
Apart from being relevant, the financial data must be faithful and reliable. This means the data should be complete and have all the data required without intentional omissions. It should not be biased; the data needs to be neutral. Also, the data should be accurate and free from errors.
How Do Relevance and Faithful Representation Ensure the Quality of the Financial Statements?
Keeping other factors aside, accounting information is meaningless without Relevance and Faithful Representation. These are the ultimate factors that ensure the quality of the accounting information or financial statements.
Relevance gives accounting information meaning and usefulness, while Faithful Representation gives it reliability. Both are essential for the decision-making process.
Relevance focuses on providing past data with the help of predicting future financial trends. Faithful Representation ensures that the data is free from errors and biased information and does not miss any relevant information.
What is Timeliness in Accounting?
Timeliness refers to how quickly accounting information can be available to users. This means that the data must be available when it is required. Information that is presented before or after it is needed loses its usefulness.
The information must be available for use at the correct time before it loses its value. Information becomes irrelevant when it is either unavailable when needed or presented when not required (that could be before or after the event for which it is needed). Some extracts of the information may still be found useful. However, efforts to create data and the effectiveness of decisions are lost.
Timeliness can also be categorized in terms of degrees. Data needs to be provided the quickest, while other data takes a few days or months to prepare and present. Also, timeliness can be considered a part of the information’s relevance factor as it also tends to provide Relevance to accounting information.
WhRelevancetrality in Accounting?
Neutrality is a part of the Faithful Representation qualitative characteristic of accounting information, as it adds the reliability factor. Neutrality refers to the absence of any biased representation of the financial data. This means that the data provided in accounting information must not be tricked or influence people to make biased decisions.
Accounting information must be precise and represented in its proper form. Data should not be intentionally omitted to influence users’ decisions. It should be unbiased and not favor a particular side or group.
After leaving Wells Fargo Bank in 2014, Daniel began a career as a finance consultant, advising companies and individuals on economic policy, labor relations, and financial management.
At Nimblefreelancer.com, Daniel writes about personal finance topics, value estimation, budgeting strategies, retirement planning, and portfolio diversification.
Read more on Daniel Smith's biography page.
Contact Daniel: daniel@nimblefreelancer.com
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