Qualitative Characteristics of Financial Information

Qualitative Characteristics of Financial Information

• Refers to characteristics that enhance the usefulness of financial statements to users, including shareholders, managers, employees, lenders, etc.

Key Concepts

• Two Fundamental Characteristics:

• Relevance:

  • Financial information must be pertinent and assist users in making decisions.

  • Relevance can entail:

  • Predictive Value: Helps predict future outcomes.

  • Confirmatory Value: Validates past forecasts.

  • An example of relevant financial information for a shareholder is the impact on investment decisions (e.g., invest more or withdraw funds).

• Faithful Representation:

  • Information must accurately represent the financial position and performance (must be complete, neutral, and free from error).

  • Breakdown of characteristics:

  • Complete: All information must be included.

  • Neutral: Information should be unbiased and not skewed for benefit.

  • Free from Error: Should avoid material errors (not implying perfection, just significant errors).

Materiality:

• Information is material if its absence or misstatement could influence decision-making.

• Example: Omission of £1 from £10,000,000 is not material, while omission of £1,000,000 is material.

• Real-world examples illustrate materiality, such as:

• Missing £20,000 in depreciation on £2,000,000 is non-material, whereas it's material on £30,000 worth of inventory.

• Improperly netting a bank loan against a cash figure misrepresents the financial status.

Aggregation and Offsetting:

• Aggregation: Combine similar items in financial statements (e.g., showing total revenues.

• Offsetting: Generally inappropriate to net liabilities and assets unless they provide a true picture of financial status (e.g., not offsetting cash against liabilities).

Prudence Principle:

• Advises caution in financial reporting; avoid overstating profits/assets and understating liabilities/expenses until certainty is established.

Substance Over Form:

• Focus on the economic reality of transactions rather than their legal form, affecting recognition of revenue and assets (e.g., recognizing sales only when there is certainty of retention by the customer).

Enhancing Qualitative Characteristics:

• Comparability: Financial statements across time periods and entities should be consistent.

• Verifiability: Figures must be capable of being verified by independent observers.

• Timeliness: Information should be presented promptly to aid decision-making.

• Understandability: Financial statements need to be comprehensible to users with a basic financial understanding.

Additional Key Accounting Concepts:

• Consistency: Ensure presentation remains consistent from period to period.

• Business Entity: Maintain clear separation between personal and business transactions.