Chapter 3
The Accounting Framework
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Understandability
Understandability
means that the financial information can be reasonably understood by its users
if the users have knowledge of the business and a basic knowledge of accounting.To be understand-
able, companies often include notes in the financial statements to explain many of the numbers,
especially those that are based on company policy. For example, details of long-term debt such as
the principal, interest rate and term would be outlined in the notes.
Comparability
Comparability
means that the financial statements of a company must be prepared in a similar
way year after year. The accounting policies used should be consistent to prevent misconceptions.
This allows a comparison of this year’s performance to past years. By comparing yearly statements,
users can identify trends in the company’s financial position and performance. For example, an
investor may be interested in observing the change in a company’s debt balance from one year
to the next to see if the company incurred additional debt or was able to pay off its creditors.The
financial information should also be comparable between companies.
Trade-Offs of Qualitative Characteristics
As discussed, accounting standards dictate that financial information should be relevant, reliable,
understandable and comparable. However, sometimes it is difficult to fully represent all of these
characteristics. There could be a trade-off among some of the characteristics. A trade-off is an
exchange of part of one characteristic for part of another.
A frequently discussed trade-off is the one between rele-
vance and reliability. For information to be relevant, it needs
to be timely. For example, presenting information that is a
few years old on today’s financial statements is likely not
very relevant. However, reliable information often requires
time to gather.
Suppose that a company chooses to prepare financial statements on a monthly basis instead of on
a quarterly or semi-annual basis. In this case, the financial statements are very timely and relevant.
However, some reliability may be given up since there is less time for the accounting staff to scru-
tinize and make necessary adjustments to the monthly financial figures. If the financial statements
were less frequent (such as quarterly or semi-annually), the accounting staff can allocate more time
to verify the accuracy and effectiveness of the statements.
Basic Assumptions and Principles
The conceptual framework of accounting also includes several basic accounting assumptions and
principles. Accountants must use their judgment to ensure that these assumptions and principles
are met by all of the financial information presented by the business.
Relevance
Reliability
Trade-off
