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Qualitative characteristics of accounting information

Qualitative characteristics of accounting information

The FASB identifies the qualitative characteristics of accounting information that provides better (more useful) information for better decision-making by the users.

These characteristics are shown below in a diagram:

characteristics of accounting

Fig: characteristics of accounting information

Lets now discuss the elaborately with examples:

Decision makers and their characteristics:

there is a divergent group of users (internal & external of accounting information their decisions may vary widely. So they need relevant and reliable accounting information.

Constraints:

1.Benefits > Cost:

the consideration of benefits and cost is a constraint rather than a characteristic of accounting information. The basic theme is:

Benefits of using information > cost of generating & providing information

Information is a valuable product, but it is not cost-free. This constraint holds that the benefits of using the accounting information must be greater than the cost of generating and presenting it to the users

Benefits > Cost

If the cost is greater than the benefit, what would happen?

Users of accounting information will be benefited certainly. On the contrary, the business entity will be financially looser. It will negatively affect the operational profit of the entity.

Example:

  1. A business entity wants to install a computerized accounting information system. Before doing so, it will justify whether the benefits of using the system is greater than the costs associated with the set up of the system and the generation of accounting information by the system.
  2. A businessman entity may not provide information about competitors because the cost of producing such information is high. (management has to hire expertise to know about the competitors which is costly)

2.Material:

Qualitative characteristics of accounting information Accounting information is a material when it has some sort of significance on users decision-making process. The inclusion or omission of a material item can change the users decision.

Example:

A business entity does not show the value of a paperweight as a fixed asset because it’s price is negligible in comparison with that of equipment. The recording of the paperweight not as a fixed asset is not material for users decision.

Understand-ability:

Understand-ability of the users can be viewed from both the practices: the prepares of accounting information

in a way so that it is understandable to the users.

Example:

While using the accounting terminology, the providers of accounting information should not use complicated terms. The term,’Machinery’ is more understandable to the users than the term. ‘plant asset.’

The user of accounting information:

Understand-ability of users mostly depends on their reasonable knowledge of business and economic activities and accounting. Not only that, user’s intention to study the information with reasonable diligence is also required.

so it does not make any sense in the providers of accounting information present the information in a understandable way to the users who have no business and accounting knowledge.

Primary Qualities:

1.Relevance:

Relevance makes the accounting information more useful for decision making. Accounting information is relevant to the extent that it is useful and meaningful to the users who use it can affect users decision. in other words, another decision can be made if relevant information is not available.

to be relevant accounting information must be capable of making a difference in a decision.

To be relevant, information need the following criteria:

  • Feedback value
  • Predictive value &
  • Timeliness

Feedback value:

Helps users confirm or correct prior expectations. It tells about the performance of the business entity over a certain period of time.

Predictive value:

Helps users predict about the future conditions of the business entity. it helps users to plan for future.

Timeliness:

Helps users to make the right decision. To be relevant, information must be presented on a timely basis.

Example:

The income statement provides information about how a business entity performed over a certain period (feedback value); it helps in planning for the next year (prediction) and it also must be communicated soon after the end of the accounting period to enable the reader to make decisions (timeliness)

Reliability:

Reliability is another significant primary quality to make information meaningful.

Accounting information is reliable to the extent that users can depend upon the information in a decision. To be reliable information need to fulfill the following criteria:

  • Verifiable
  • Neutrality &
  • Accuracy (Representational faithfulness)

a) Verifiable:

Qualitative characteristics of accounting information Accounting information must be credible and justifiable by independent parties using the same methods of measuring it.

b) Neutrality:

Information cannot be selected to favor one set of interested parties (usually management) over another. It must be fair and factual, not biased.

Example:

the balance sheet should represent the assets, liabilities and owner’s equity of a business enterprise over a certain period of time as faithfully as possible (Accuracy) without any bias (neutrality) which can be verifiable by an auditor (variability).

Secondary Qualities:

Comparability and consistency are two important secondary qualities. Information about an enterprise is more useful if it can be compared with similar information about another enterprise (Comparability) and with similar information about the same enterprise over time (consistency)

Comparability:

Information that has been measured and reported in a similar manner for different enterprises is considered comparable. The users compare between similar information of different enterprises and have practical ideas about the similarities and the differences of information. This will lead the users to make the right decision. But the user must keep in  mind that comparison between enterprises becomes appropriate when the nature of the business entity is of the same nature.

Consistency:

When entity applies the same accounting treatment to similar events from period to period, the entity is considered to be consistent in the user of accounting standards. this does not mean that companies cannot switch from one method of accounting to another. But the nature and effect of the accounting change, as well as the justification for it, must be disclosed in the financial statements for the period in which the change is made. consistent use of accounting measures and procedures is important in achieving comparability.

Qualitative characteristics of accounting information

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