Question

Explain how fair value affects the relevances and reliability of financial statement using a example from the pacific.

Answer 1

Relevance and reliability are two of the four key qualitative characteristics of financial accounting information. The others being understandability and comparability.

Relevance requires that the financial accounting information should be such that the users need it and it is expected to affect their decisions.

Reliability requires that the information should be accurate and true and fair.

Relevance and reliability are both critical for the quality of the financial information, but both are related such that an emphasis on one will hurt the other and vice versa. Hence, we have to trade-off between them. Accounting information is relevant when it is provided in time, but at early stages information is uncertain and hence less reliable. But if we wait to gain while the information gains reliability, its relevance is lost.

Examples

1. After the balance sheet date but before the date of issue a company wants to dispose of one of its subsidiaries and is in final stages of reaching a deal but the outcome is still uncertain. If the company waits they are expected to find more reliable information but that would cost them relevance. The information would be outdated and no longer very relevant.
2. After the balance sheet date during the time when audit is carried out, it becomes clear which debts were realized and where were not hence it improves the reliability of allowance for bad debts estimate but the information loses its relevance due to too much time being taken. Timeliness is key to relevance.