Chapter 3
The Accounting Framework
65
Qualitative Characteristics of Financial Information
There are fundamental characteristics in the accounting framework upon which accounting standards
are based. These characteristics form the foundation of the conceptual framework and define how
information should be presented in financial statements. For financial statements to be effective,
financial information should be relevant, reliable, understandable, and comparable.
Relevance
Relevance
means that all information useful for decision making is present in the financial state-
ments. Information is relevant if it helps users predict future performance or confirms previous
predictions. For example, if an investor wants to predict the future cash flows of a company, and
the company deliberately avoided reporting a bank loan, the investor would not understand the
company’s debt correctly. Therefore, the investor would not be able to accurately predict the
company’s interest expenses and available cash flow.This means the balance of the bank loan would
be considered relevant financial information.
Another component of relevance is
timeliness
. Information is timely if there is no delay in reporting
crucial information. To be useful to a decision maker, information must be received before it is no
longer able to influence decisions. For instance, a business owner may prefer to have monthly state-
ments prepared to help monitor the company’s performance. If the business only prepares annual
statements, the information may be available too late to correct problems with the company.
Reliability
Reliability
means that information is free from significant error and bias. In other words, different
independent people looking at the evidence will arrive at the same values.The activities that a busi-
ness records must be based on objective evidence. A component of reliability is
verifiability
. For
example, if a company records an expense transaction in its financial records, an invoice must be
provided to back it up (i.e. the expense can be verified).
Another component of reliability is
conservatism
.Whenever an accountant needs to exercise their
own interpretation or judgment in applying an accounting standard and has several options, the
least optimistic option should be selected. In other words, the accountant should choose the option
that results in a lower balance of assets, lower net income or a higher balance of debt.
Reliability also relies on the
representational faithfulness
of the information. This means that
transactions must be presented as their true economic substance rather than their legal form. For
example, a company that leases a machine for its entire useful life may list the machine as an asset
even though it does not legally own the machine.
The concept of
neutrality
also states that financial information must be free from bias. Bias occurs
when the information is influenced by the interests of particular users. For example, managers may
be tempted to report higher sales and profit figures if they are paid a bonus based on the success of
their department.
