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 refers 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 are the features that bring enhancement to the data.
When is Accounting Information Considered to be Relevant?
Accounting Information is considered relevant when confirmatory and predictive value is added. These values bring accuracy to the accounting information and improve its relevance. They play an imperative role in the process of financial decision-making.
If the accounting information includes data about past financial events, it brings 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 brings predictive value to the information.
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 bring usefulness to accounting information.
What is Meant by Comparability When Discussing Financial Accounting Information?
In discussing financial accounting information, comparability refers to evaluating financial data from different financial periods. The data includes financial policies, accounting standards, and company trends in different accounting periods. Accounting information provides such data makes it easy for company officials to compare how different financial strategies performed and make better decisions for future strategies.
Comparable data helps to track the progress of the financial policies and strategies of the company. Such data can be in cash flow statements, balance sheets, and other financial reports, which makes the comparison easy. It helps to understand the alternative courses of action and choose the best one amongst them.
Comparison can be between the financial data of different periods of the same company or that with a competitor’s. Such comparison helps 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. Out of which two are considered to be the fundamental or primary characters, namely Representational Faithfulness and Relevance. These factors are considered an essential part of 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 financial 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 enhance the information, making it clearer and more 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 require accounting or financial information, like managers, creditors, the public, government, investors, or lenders. The information solves different purposes for these groups. For example, comparability will help investors decide where to invest for better returns. Verifiability will give the creditors more confidence to decide 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 can be defined as the standard accounting rules that must be followed while preparing a company’s financial statements. As per the FASB, companies have to follow these rules to create standardized financial information.
Because of accounting principles, companies cannot prepare financial statements as and how they want them and include only the information that will prove beneficial to them. The significant relevance of the accounting principle is to remove 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 considered essential and work as a team to make the data more useful which would otherwise have no value.
Relevance is the first and the foremost feature that needs to be added to the financial information. By relevance, we mean adding aspects to the data 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 confirmatory (data of past financial events) and predictive (efficiency in predicting future events) value to the information.
Apart from being relevant, the financial data must also be faithful and reliable. This means the data should be complete and have all the necessary data 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 the accounting information meaning and usefulness, while Faithful Representation gives it reliability. Both of them are essential for the decision-making process.
Relevance focuses on providing past data with the help of predicting future financial trends. Faithful Representation makes sure that the data is free from errors and biased information and that it is not missing any relevant information.
What is Timeliness in Accounting?
Timeliness refers to how quickly the accounting information can be made available at its user’s disposal. This means that the data must be available when it is required. If information is presented before or after it is needed, it loses its usefulness.
It is vital that the information is available for use at the correct time before it loses its value. Information becomes irrelevant when it is either not available when it is 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, the efforts to create the data and the decisions’ effectiveness are lost.
Timeliness can also be categorized in terms of degrees. Data needs to be provided the quickest, while there is data that takes a few days or months to be prepared and presented. Also, timeliness can be considered a part of the relevance factor of the information as it also tends to provide relevance to the accounting information.
What is Neutrality in Accounting?
Neutrality is a part of the Faithful Representation qualitative characteristic of accounting information, as it brings the reliability factor to it. Neutrality refers to the absence of any biased representation of the financial data. This means that the data provided in the accounting information must not be tricked or should influence people to make biased decisions.
The accounting information must be precise and represented in its proper form. The data should not be intentionally omitted to influence the decision of its users. It should be unbiased and not favor a particular side or group of people.
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
