Qualitative Characteristics of Accounting Information
According to the FASB there are two basic qualitative characteristics of accounting information:
- Primary Qualities and
- Secondary Qualities.
These qualitative characteristics are useful in making difference in decision-making by differencing between better information and inferior information for. The primary and secondary qualities are described below with appropriate examples.
Primary Qualities: Relevance and Reliability
Relevance: the accounting information of the financial report should be relevant. The first prerequisite for maintaining the relevancy of accounting information is that, the accounting information that is presented in the financial report should be able to make difference in decision making or cooperate in decision making.
The decision maker or the users of the accounting information could be able to take decision based on the accounting information. The decision maker and the users become able to forecast the future event and to compare the financial effect of past, present, and future based on relevant account information.
Relevant accounting information basically has three characteristics
- (a) Predictive value
- (b) Feedback value
- (c) Timeliness
Relevant accounting information has predictive value as it can help the decision maker to predict the future event of financial effect.
If accounting information has feedback value, then the information is relevant as feedback value of relevant accounting information assist decision maker or user of accounting information to confirm and correct prior expectations.
Many companies’ issues their interim report on the basis of forecasting annual earnings and feedback on past performance to maintains its relevancy.
And timeliness of relevant information makes available accounting information to decision makers within proper time, before it loses its ability to persuade their decision making. If information will not be available when it is required, then it will lack relevance and usefulness. Though timeliness alone is unable to ensure relevancy of accounting information, but a lack of timeliness reduces its possible relevance.
For example if a company issues a report after 4 months of its reporting then accounting information of this report will be less beneficiary for decision making.
So in order to keep relevancy of information, the information should have predictive value and feedback value, reported on a timely basis.
Reliability: another primary quality of accounting information is reliability. Accounting information should be reported with reliability to maintain its qualitative characteristic.
In most cases the users become unable to evaluate the accurate content of the information due to lack of time and skill. Thus, the accounting information of should be reliable to make financial report proper.
The accounting information will be considered as reliable if it is a faithful representation, and is reasonably free of any error and bias.
Verifiability: Accounting information is regard as faithful presentation when verifiability occurs. Verifiability occurs only when measurers or accountants can agree that the selected method has been applied without any error or bias as the measurement results sometimes can be duplicated. Verification is worked as a very effective tool for reducing measurer bias by using the same method to repeat measurements. This can remove both unintentional and intentional errors.
Though verification can reduce the measurer bias, but it does not provide an assurance that the accurate accounting methods has applied. Representational faithfulness ensures that quality of accounting information.
Representational faithfulness: accounting information is reliable if there is a representational faithfulness which refer that the numbers and descriptions match what is really existed or occurred in the financial statement. Generally representational faithfulness of accounting information provide the idea that there is a perfect and accurate relationship between the reported accounting measurements or descriptions and the economic resources, obligations, and transactions and events causing changes in these items.
For example, in the income statement of ABC Company, the financial statement has reported sales of $300 billion when it had actually sales of $180 billion, which refer that the statement has failed to faithfully represent the appropriate sales amount.
If any financial statement has a high degree of representational faithfulness then it will be helpful for reducing measurement bias but it does not always ensure that accounting information will also be relevant in all decision contexts.
Neutrality: having neutrality means accounting information is not biased to provide a prearranged result or does not select information to favor one set of interested parties over another. Neutrality of accounting information provides assurance that it is free from any biasness. Neutrality also specifies the completeness of accounting information which is very useful to ensure its biasness. However, any exclusion of information can sometimes create bias if it is proposed for persuading a particular behavior.
Accounting information makes available many areas of interests to the different users and makes difference in the decision of decision makers but not in a predetermined trend. So having neutrality does not indicate that accounting information has no purpose or does not influence the decision makers or users.
Secondary Qualities: Comparability and Consistency
Accounting information about a company that is presented in the financial statement is more useful if decision makers become able to compare it with similar information from another company and with similar information about the same company from past periods. And to do so there are two qualitative characteristic which are called as a secondary qualitative characteristic of accounting information because they consist of more than one item of information.
- (a) Comparability and
- (b) Consistency
Comparability: if accounting information is measured and reported in a similar approach for different companies then it is considered as comparable. Comparable information also helps in evaluating resource allocation decisions. The users of accounting can detect and explicate similarities and differences between two or more areas of economic events between companies due to comparability of accounting information.
For example, the accounting for pensions of the United States will differ from pensions of the Japan. In U.S. companies record their pension cost as incurred but in Japan, companies generally recorded their pension cost as little or no charge to income for these costs. Accordingly, it is difficult to compare and evaluate the financial results of General Motors to Japanese competitors.
Consistency: consistency is related to comparability. Accounting information will be consistent when a company applies the same accounting policies and procedures to similar economic events from period to period. Lacking consistency, the users or decision makers cannot able to verify whether differences in economic results were caused by economic differences or simply by differences in accounting methods.
The consistent accounting presentation does not refer that the companies cannot adopt different accounting method. Sometimes the accounting method could be changed due to changes in economic situations or adoption of new accounting methods. In order to gain the best usefulness of its accounting information, a company must make some sacrifice in consistency at certain times.