Question

The International Accounting Standards Committee’s Framework for the Preparation of Financial Statements identifies four primary qualitative characteristics.

a. Discuss the four qualitative characteristics identified by the IASB.

b. Contrast and compare these qualitative characteristics with the qualitative characteristics identified by the FASB in SFAC No. 8.

Thank you

Answer 1

(a) Qualitative characteristics are the attributes that make the information provided in financial statements useful to users. The four principal qualitative characteristics are understandability, relevance, reliability and comparability.

a.1. Understandibility :- An essential quality of the information provided in financial statements is that it is readily understandable by users. For this purpose, users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence. However, information about complex matters that should be included in the financial statements because of its relevance to the economic decision-making needs of users should not be excluded merely on the grounds that it may be too difficult for certain users to understand.

a.2 Relevance ;-   To be useful, information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. The predictive and confirmatory roles of information are interrelated. For example, information about the current level and structure of asset holdings has value to users when they endeavour to predict the ability of the entity to take advantage of opportunities and its ability to react to adverse situations. The same information plays a confirmatory role in respect of past predictions about, for example, the way in which the entity would be structured or the outcome of planned operations. Information about financial position and past performance is frequently used as the basis for predicting future financial position and performance and other matters in which users are directly interested, such as dividend and wage payments, security price movements and the ability of the entity to meet its commitments as they fall due. To have predictive value, information need not be in the form of an explicit forecast. The ability to make predictions from financial statements is enhanced, however, by the manner in which information on past transactions and events is displayed. For example, the predictive value of the income statement is enhanced if unusual, abnormal and infrequent items of income or expense are separately disclosed.

a.3 Comparability :- Users must be able to compare the financial statements of an entity through time in order to identify trends in its financial position and performance. Users must also be able to compare the financial statements of different entities in order to evaluate their relative financial position, performance and changes in financial position. Hence, the measurement and display of the financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and over time for that entity and in a consistent way for different entities. An important implication of the qualitative characteristic of comparability is that users be informed of the accounting policies employed in the preparation of the financial statements, any changes in those policies and the effects of such changes. Users need to be able to identify differences between the accounting policies for like transactions and other events used by the same entity from period to period and by different entities. Compliance with International Accounting Standards, including the disclosure of the accounting policies used by the entity, helps to achieve comparability. The need for comparability should not be confused with mere uniformity and should not be allowed to become an impediment to the introduction of improved accounting standards. It is not appropriate for an entity to continue accounting in the same manner for a transaction or other event if the policy adopted is not in keeping with the qualitative characteristics of relevance and reliability. It is also inappropriate for an entity to leave its accounting policies unchanged when more relevant and reliable alternatives exist. Because users wish to compare the financial position, performance and changes in financial position of an entity over time, it is important that the financial statements show corresponding information for the preceding periods.

a.4 Reliability :- To be useful, information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading. For example, if the validity and amount of a claim for damages under a legal action are disputed, it may be inappropriate for the entity to recognize the full amount of the claim in the balance sheet, although it may be appropriate to disclose the amount and circumstances of the claim.

(b) The Financial Accounting Standards Board continued making progress on its Conceptual Framework Project by issuing a new concept statement earlier this week. The Conceptual Framework Project is a joint effort with the IASB, aimed at producing a signal framework that both Boards could use in developing (ideally converged) standards.

This new concept statement, SFAC 8, deals with the objectives of financial reporting and the qualitative characteristics of accounting information and so is a replacement of SFAC 1 and 2, respectively. The new statement is available on the FASB’s website here.

Having now read through both chapters and the basis for conclusions, I have to say that my first impression is that chapters are refreshingly succinct, especially as compared to Concept Statements 1 and 2.

Noteworthy items in the Objectives chapter:

• Although the word “stewardship” does not show up in the statement on objectives, the Board clearly indicates that one purpose of financial reporting is to provide information that allows users to assess how efficiently and effectively management has been in using the reporting entity’s resources.
• In the basis, they also indicate that there was never an intention to subjugate stewardship decisions to investment and credit decisions. However, they also note that information designed for resource allocation will also generally be useful for assessing management performance.
• In reaffirming that investors and creditors are the primary user group for general purpose financial statements, the Board (not surprisingly) discusses the push that was made during the recent financial crisis to make maintaining financial stability an objective of financial reporting.

Noteworthy items in the Characteristics chapter:

• Reliability has been replaced by faithful representation; timeliness and verifiability are now enhancing characteristics, rather than components of relevance and reliability, respectively; and the Board provides a clear priority when applying the fundamental characteristics – saying, essentially, first identify a relevant economic phenomenon and then consider whether it can be faithfully represented in the financial statements.
• The components of faithful representation are: completeness, neutrality, and freedom from error.
• Freedom from error does NOT mean the same thing as “accurate” or “precise”. Instead, it is described as meaning that “there are no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process.” Honestly, I found this point to be a little subtle and, given the inclusion of the other two components (completeness and neutrality), I’m not sure how much the notion of free from error adds, especially given the likelihood that it will be misinterpreted by lay readers as implying accuracy or precision.

Overall, the new hierarchy of information characteristics is significant improvement over the previous hierarachy .