CHAPTER 3 & 4

• Qualitative characteristics of financial information


  The qualities or attributes that make financial accounting information useful to others
• Fundamental qualitative characteristics

  • Relevance
  • Faithful representation
• Applying the fundamental qualitative characteristics

  1. Identify an economic phenomenon or transaction that has the potential to be useful

  2. Identify the type of information about the phenomenon or transaction that would be most relevant and can be faithfully represented

  3. Determine whether the information is available
• Relevance


  The capacity of the information to influence a decision
• Ingredients of relevance

  • Predictive value
  • Confirmatory value
• Predictive value

  If it can be used as an input to processes employed by users to predict future outcome
• Confirmatory value


  If it provides feedback about previous evaluation
• Materiality

  An item is material if knowledge of it could reasonably affect or influence the economic decision of the primary users of the financial statements
• New definition of materiality

  If the omission, misstatement and obscuring of the information could reasonably affect the economic decision of primary users
• Factors considered in determining materiality

  • Could reasonably be expected to influence
  • Obscuring information
  • Primary users
• Faithful representation

  Financial reports represent economic phenomena or transactions in words and numbers
• Ingredients of faithful representation

  • Completeness
  • Neutrality
  • Free from error
• Completeness of financial information

  Relevant information should be presented in a way that facilitates understanding and avoids erroneous implication
• Standard of adequate disclosure

  Completeness is the result of the standard of adequate disclosure or principle of full disclosure
• Notes to financial statements in relation to completeness

  All significant and relevant information leading to the preparation of financial statements shall be clearly reported
• Neutrality of financial information

  A neutral depiction is without bias in the preparation or presentation of financial information
• Prudence


  The exercise of care and caution when dealing with the uncertainties in the measurement process such that assets or income are not overstated and liabilities of expenses are not understated
• Conservatism

  When alternatives exist, the alternative which has the least effect on equity should be chosen
• Free from error financial information

  There are no errors or omissions in the description of the phenomenon or transaction
• Effect of measurement uncertainty on usefulness of financial information

  Arises when monetary amounts in financial reports cannot be observed directly and must instead be estimated
• Substance over form

  If information is to represent faithfully the transactions and other events it purports to represent, it is necessary that the transactions and events are accounted in accordance with their substance and not merely their legal form
• Enhancing qualitative characteristics

  • Comparable
  • Understandable
  • Verifiable
  • Timely
• Comparability

  The ability to bring together for the purpose of noting points of likeness and difference
• Comparability within a single entity

  The quality of information that allows comparisons within a single entity through time or from one accounting period to the next. horizontal comparability or intracomparability
• Comparability between and across entities

  The quality of information that allows comparisons between two or more entities engaged in the same industry. intercomparability or dimensional comparability
• Consistency

  The uniform application of accounting method from period to period within an entity
• Consistency vs Comparability

  Consistency is the uniform application of accounting method from period to period within an entity. Comparability is the uniform application of accounting method between and across entities in the same industry
• Understandability


  Requires that financial information must be comprehensible or intelligible if it is to be most useful
• Verifiability

  Different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation
• Types of verification

  • Direct verification
  • Indirect verification
• Direct verification


  Verifying an amount or other representation through direct observation, for example, by counting cash
• Indirect verification


  Checking the inputs to a model, formula or other technique and recalculating the inputs using the same methodology
• Timeliness

  Financial information must be available or communicated early enough when a decision is to be made
• Cost constraint on useful financial information

  Cost incurred in generating financial information against the benefit to be obtained from having the information
• Assessing whether the cost of reporting outweighs or falls short of the benefit is difficult to measure and becomes a matter of professional judgment
• General objective of financial statements

  Provide information about economic resources of the reporting entity, claims against the entity and changes in the economic resources and claims
• Reporting period

  A month, quarter, or a year for which the financial statement of an organization is prepared
• Reporting entity

  An entity that chooses, or is required, to present general purpose financial statements
• Types of financial statements

  • Consolidated financial statements
  • Unconsolidated financial statements
  • Combined financial statements
• Consolidated financial statements

  The financial statements prepared when the reporting entity comprises both the parent and its subsidiaries