Question

Provide a brief description of the qualitative characteristics of useful information including relevance/materiality and the cost constraint.

Answer 1

• Qualitative characteristics

• Following are the key qualitative characteristics of financial statements, as laid out in the framework:
  • Relevance
  • Materiality
  • Faithful representation, including substance over form
• The framework also outlines certain other factors which enhance the qualitative characteristics of financial statements. These are
  • Comparability
  • Verifiability
  • Timeliness
  • Understandability
• Each of the above points are discussed in detail below:
  • Relevance

The framework states that the users should be provided information which is relevant to them. Too much information should be avoided, and similarly, too little information also may not help the users. Information provided should be relevant to the decisions the various stakeholders need to make. Information is considered relevant if it has some predictive or confirmatory value, or both. The relevance of information is generally determined by its nature (i.e. what type of information is being provided) and its materiality (discussed further below).

• Materiality

Information is material if omitting it or misstating it could influence the decisions of the users that the users make on the basis of financial information about a specific reporting entity.

Materiality need not always be assessed in terms of quantum of the amounts involved. For eg. if Directors remuneration paid is over the limits laid by the concerned corporate law in place even by a small amount, such information indicates non compliance with the laws of land and hence, though the amount concerned may not be significant, the information will still be considered to be material

• Faithful representation, including substance over form

Faithful representation warrants that the financial statements should reflect information which is complete, neutral and free from error. Further, the accounting for the particular transaction should reflect the substance of the transaction, rather than the mere legal form, considering that IFRS are meant to be principle-based standards.

A complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations.

A neutral depiction means that information must not be manipulated in any way in order to influence the decisions of users. The recording and reporting of transactions should be free from any individual bias.

Free from error means there are no errors or omissions in the description of the phenomenon and no errors made in the process by which the financial information was produced. It does preclude any inaccuracies from arising, particularly where estimates have to be made.

Substance over form, as per IASB, is implied in faithful representation of a transaction because faithful representation is only possible if transactions are accounted for according to their substance and economic reality.

• Comparability

The primary objective of the financial statements is to enable users to take varied decision. These decisions often involve selection of one entity among various options available to the decision maker, for eg. which entity to invest in out of multiple options available. This requires that the financial statements of various entities must be comparable, i.e. similar items should look similar and different items must look different.

Consistency, though related, is different from comparability. Consistency refers to usage of same methods for same items, from period to period, within a reporting entity or in a single period, across entities.

Providing multiple accounting policy choice for similar transactions/balances tends to dilute the characteristic of comparability. Many countries who adopt IFRS, often tend to reduce the accounting policy options provided by IFRS to suit their local regulatory and economic environment.

• Verifiability

The information provided in the financial statements should be verifiable. Verifiability means different knowledgeable and independent observers could reach a reasonable consensus that a particular piece of information is faithfully depicted in the financial statements.

Verification can be direct or indirect. Direct verification means verifying an amount or other representation through direct observation, eg. verify cash by counting cash.

Indirect verification means checking the inputs to a model, methodology or other technique used to calculate the amount.

This usually requires entities to disclose the underlying assumptions, methods of compiling the information and other information and factors relevant to support the other information, for eg. carrying amount if inventory is verified by checking the inputs (cost, quantity), and recalculating the ending inventory using the same cost flow assumption (for eg. first in first out, weighted average method).

• Timeliness

Timeliness is another critical element for decision makers. Financial statements should be available to the users within a reasonable time frame. Older the information becomes, less useful and relevant it becomes.

IFRS of course, does not prescribe any timelines for presentation of financial statements (remember these are principal based standards). Generally, the timelines within which the financial statements should be available for use to public is prescribed by local lay, typically by stock exchanges where the entities are listed.

• Understandability

Presenting the information in a clear, concise manner, which includes aggregating and grouping the information in a systematic manner with proper cross referencing to schedules and disclosure makes the information understandable.

However, the framework appreciates that some economic phenomena are inherently complex. Even well informed and diligent users may need to seek aid of an advisor for understanding these. This does not preclude such information from being included in the financial statements as exclusion of such information would render the financial statements incomplete and potentially misleading.

Finally, the concept of cost constraints simply states that for providing the relevant information as outlined above, the cost of gatherint the information should not exceed the benefit derived from reporting the information, for eg, a company may want to provide division wise information to certain target users, but as on date, the systems are set up such that the information is not easily available and my take a significant quantum of time and effort to pull out, the entity may not choose to put in those costs and efforts, unless it is looking for a huge funding or investment by a partner.