Please describe some general desirable characteristics of accounting measurements.

Expert Solution

1. Relevance:

Relevance is closely and directly related to the concept of useful information. Relevance implies that all those items of information should be reported that may aid the users in making decisions and/or predictions. In general, information that is given greater weight in decision-making is more relevant.

Specially, it is information’s capacity to make a difference that identifies it as relevant to a decision. American Accounting Association’s Committee to Prepare A Statement of Basic Accounting Theory defines relevance as “the primary standard and requires that information must bear upon or be usefully associated with actions it is designed to facilitate or results desired to be produced”.

Financial Accounting Standards Board in its Concept No. 1 comments:

“Relevant Accounting information must be capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present and future events or to confirm or correct expectations.”

The question of relevance arises after identification and recognition of the purpose for which the information will be used. It means that information relevant for one purpose may not be necessarily relevant for other purposes. Information that is not relevant, is useless because that will not aid users in making decisions.

2. Reliability:

Reliability is described as one, of the two primary qualities (relevance and reliability) that make accounting information useful for decision-making. Reliable information is required to form judgements about the earning potential and financial position of a business firm. Reliability differs from item to item.

Some items of information presented in an annual report may be more reliable than others. For example, information regarding plant and machinery may be less reliable than certain information about current assets because of differences in uncertainty of realisation. Reliability is that quality which permits users of data to depend upon it with confidence as representative of what it purports to represent.

3. Understandability:

Understandability is the quality of information that enables users to perceive its significance. The benefits of information may be increased by making it more understandable and hence useful to a wider circle of users. Presenting information which can be understood only by sophisticated users and not by others, creates a bias which is inconsistent with the standard of adequate disclosure.

Presentation of information should not only facilitate understanding but also avoid wrong interpretation of financial statements. Thus, understandable financial accounting information presents data that can be under-stood by users of the information and is expressed in a, form and with terminology adopted to the user’s range of understanding.

4. Comparability:

Economic decision requires making choice among possible courses of actions. In making decisions, the decision-maker will make comparisons among alternatives, which is facilitated by financial information. Comparability implies to have like things reported in a similar fashion and unlike things reported differently.

Hendriksen observes that the “primary objective of comparability should be to facilitate the making of predictions and financial decisions by creditors, investors and others”. He defines comparability as “the quality or state of having enough like characteristics to make comparisons appropriate”.

FASB (USA) Concept No. 2 (pare 115, 1980) defines comparability, “….as the quality or state of having certain characteristics in common, and comparison is normally a quantitative assessment of the common characteristics. Clearly, valid comparison is possible only if the measurements used—the quantities or ratios— reliably represent the characteristic that is the subject of comparison”.

Comparable financial accounting information presents similarities and differences that arise from basic similarities and differences in the enterprise or enterprises and their transactions, and not merely from difference in financial accounting treatment.

Information, if comparable, will assist the decision-maker to determine relative financial strengths and weaknesses and prospects for the future, between two or more firms or between periods in a single firm.

Financial reports of different firms are not able to achieve comparability because of differences in business operations of companies and also because of the management’s viewpoints in respects of their transactions. Also, because there are different accounting practices to describe basically similar activities.

Two corporate managements may view the similar risk, uncertainty, benefit or sacrifice in different fashions and, thus, this would lead to different implications of financial statements. With information that facilitates interpretation, users are able to compare and assess the results of similar transactions and other events among enterprises.

Efforts, therefore, should be directed towards developing accounting standards to be applied in appropriate circumstances to facilitate comparisons and interpretation of data: areas of differences in accounting practices, which are not justified by differences in circumstances, should be narrowed; selection of an accounting practice should be based on the economic substance of an event or a transaction being measured and reported; and a desire to produce a particular financial statement result should not influence choice between accounting alternatives.

5. Consistency:

Consistency of method over a period of time is a valuable quality that makes accounting numbers more useful. Consistent use of accounting principles from one accounting period to another enhances the utility of financial statements to users by facilitating analysis and understanding of comparative accounting data.

It is relatively unimportant to the investor what precise rules or conventions are adopted by a company in reporting its earnings, if he knows what method is being followed and is assured that it is followed consistently from year to year.

Lack of consistency produces lack of comparability. The value of inter-company comparisons is substantially reduced when material differences in income are caused by variations in accounting practices.

The quality of consistency can be applied in different situations, e.g., use of same accounting procedures by a single firm or accounting entity from period to period, the use of similar measurement concepts and procedures for related items within the statement of a firm for a single period, and the use of same procedures by different firms.

If a change in accounting practices or procedures is made, disclosure of the change and its effects permits some comparability, although users can rarely make adjustments that make the data completely comparable.

Consistency in the use of accounting procedures over a period is a user constraint, otherwise there would be difficulty in making predictions. If different measurement procedures are adopted, it is difficult to predict trends in earning power or financial position of a company.

If assets are valued at cost in some periods, and at replacement cost in others, the firm’s earning power may be distorted, especially when the difference in cost and replacement cost is significant over a period of time.

Although consistency in the use of accounting principles from one accounting period to another is a desirable quality, but it, if pushed too far, will prove a bottleneck for bringing about improvements in accounting policies, practices, and procedures. No change to a preferred accounting method can be made without sacrificing consistency; there is no way that accounting can develop without change.

Users’ needs may change over time which would require a change in accounting principles, standards and methods. These improvements are needed to serve users’ needs in changing circumstances. When it is found that current practices or presentations being followed are not fulfilling users’ purposes, a new practice or procedure should be adopted.

According to Backer, “different accounting methods are needed to reflect different management objectives and circumstances. The consensus of opinion among analysts interviewed was that standards are desirable as guidelines to financial reporting, but that management should be free to depart from these standards provided methods used and their effects are clearly disclosed”. Thus, consistency and uniformity in accounting methods would not necessarily bring comparability.

Instead of enforced uniformity, accounting standards should be developed which would be best or preferred methods in most cases. Such accounting standards should be followed unless there is a compelling reason why they will not provide a correct and useful reflection of business operations and results.

Also, full disclosure should be made of the alternative method applied and, whenever practical, of the monetary difference resulting from deviations from the standard. To conclude, consistency is desirable, until a need arises to improve practices, policies, and procedures