Helping students to understand, rather than just memorise, IFRS principles The IFRS Conceptual Framework underpins what international financial reporting standards say and why they identify a particular accounting treatment. Students must understand this if they are to understand wider IFRS principles. An important aspect of the Conceptual Framework is an attempt to define “high quality” information, or
in other words, what makes financial information useful. According to the Conceptual Framework, useful information has the qualitative characteristics of being relevant, and faithfully represents the underlying event, that is, the words and numbers on the screen or the page should communicate the underlying economic reality. Now I think of these characteristics as cats – just because it helps me to imagine how these
characteristics work. So we have two cats – Relevance and Faithful representation – and they are the primary qualitative characteristics of useful financial information. Relevance means that information has predictive or confirmatory value – it can help users to predict future outcomes, for example future profits, or it can confirm or refute previous predictions. Faithful
representation means a depiction which is complete, neutral and free from error. Then there are four secondary characteristics known as enhancing qualitative characteristics which also contribute to high-quality information. And I think of these as kittens and they are: Comparability: good quality information allows users to compare the financial results of a business over time or with other businesses. Verifiability: different observers are able to agree on what the information means. Understandability: information should be understandable to users with a reasonable level of knowledge. Timeliness: information tends to be more useful if it is more current. These secondary characteristics are kittens because they are enhancing rather than overriding. If there is a conflict between the primary characteristics and the secondary characteristics then the primary characteristic prevails. For example, you cannot oversimplify information to the extent that it is no longer a faithful representation just to make it more understandable – because faithful representation is a cat (a primary characteristic) and understandability is a kitten (a secondary characteristic). If the underlying economic phenomenon is complex, and therefore inherently difficult to understand, then its representation will be complex. Now one final point about quality – in any business decision there is an overriding cost quality trade-off and this is formalised in the Conceptual Framework as the cost constraint. The costs of reporting better quality financial information need to be justified by the extra benefits of that better quality financial information. So there is a balance to be struck between maximising the qualitative characteristics of financial information and producing that information at an acceptable cost. I think of the cost constraint as a big angry dog, Fido, because, well, how else do you keep cats and kittens in line? © AccountingCafe.org Download presentation (700KB PDF) The fundamental (primary) and enhancing (secondary) qualitative characteristics What are the Qualitative Characteristics of Accounting Information?The demand for accounting information by investors, lenders, creditors, etc., creates fundamental qualitative characteristics that are desirable in accounting information. There are six qualitative characteristics of accounting information. Two of the six qualitative characteristics are fundamental (must have), while the remaining four qualitative characteristics are enhancing (nice to have).  Fundamental (Primary) Qualitative CharacteristicsQualitative characteristics of accounting information that must be present for information to be useful in making decisions:
Enhancing (Secondary) Qualitative CharacteristicsQualitative characteristics of accounting information that impact how useful the information is:
We will look at each qualitative characteristic in more detail below. RelevanceRelevance refers to how helpful the information is for financial decision-making processes. For accounting information to be relevant, it must possess:
Therefore, accounting information is relevant if it can provide helpful information about past events and help in predicting future events or in taking action to deal with possible future events. For example, a company experiencing a strong quarter and presenting these improved results to creditors is relevant to the creditors’ decision-making process to extend or enlarge credit available to the company. Representational FaithfulnessRepresentational faithfulness, also known as reliability, is the extent to which information accurately reflects a company’s resources, obligatory claims, transactions, etc. To help, think of a pictorial depiction of something in real life – how accurately does the picture represent what you see in real life? For accounting information to possess representational faithfulness, it must be:
VerifiabilityVerifiability is the extent to which information is reproducible given the same data and assumptions. For example, if a company owns equipment worth $1,000 and told an accountant the purchase cost, salvage value, depreciation method, and useful life, the accountant should be able to reproduce the same result. If they cannot, the information is considered not verifiable. TimelinessTimeliness is how quickly information is available to users of accounting information. The less timely (thus resulting in older information), the less useful information is for decision-making. Timeliness matters for accounting information because it competes with other information. For example, if a company issues its financial statements a year after its accounting period, users of financial statements would find it difficult to determine how well the company is doing in the present. UnderstandabilityUnderstandability is the degree to which information is easily understood. In today’s society, corporate annual reports are in excess of 100 pages, with significant qualitative information. Information that is understandable to the average user of financial statements is highly desirable. It is common for poorly performing companies to use a lot of jargon and difficult phrasing in its annual report in an attempt to disguise the underperformance. ComparabilityComparability is the degree to which accounting standards and policies are consistently applied from one period to another. Financial statements that are comparable, with consistent accounting standards and policies applied throughout each accounting period, enable users to draw insightful conclusions about the trends and performance of the company over time. In addition, comparability also refers to the ability to easily compare a company’s financial statements with those of other companies. The qualitative characteristics of accounting information are important because they make it easier for both company management and investors to utilize a company’s financial statements to make well-informed decisions. More ResourcesThank you for reading CFI’s guide on Qualitative Characteristics of Accounting Information. To keep learning and advancing your career, the following resources will be helpful:
What are the four main qualitative characteristics of financial statements?The four enhancing qualitative characteristics are comparability, verifiability, timeliness and understandability.
What are the four key elements of the conceptual framework?The conceptual framework is composed of a basic objective, fundamental concepts, and recognition, measurement, and disclosure concepts.
What are the characteristics of a conceptual framework?Enhancing characteristics, shown below, are comparability, verifiability, timeliness, and understandability.. Comparability. Information that is measured and reported in a similar manner for different companies is considered comparable. ... . Verifiability. ... . Timeliness. ... . Understandability.. What are the fundamental qualitative characteristics identified in the IASB conceptual framework for financial reporting?The fundamental qualitative characteristics are relevance and faithful representation. Relevant financial information is capable of making a difference in the decisions made by users.
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