Accounting - Language of Business: Qualitative

Characteristics of Useful Financial Information

What is Accounting?

Accounting is the process of recording, classifying, summarizing, analyzing, and interpreting

financial transactions to provide accurate and timely information to users of the financial statements, such
as investors, creditors and management.

It is often described as the language of business because it is the medium of communication

between the business firm and the various parties interested in its financial activities.

More than what it is, accounting gives financial information to people such as:

● Owners ● Investors ● Government

● Managers ● Creditors ● Employees

Financial information helps these groups to make decisions.

Accounting transmits financial information by means of periodic reports or rather known as the
Principal Accounting Reports. These reports are the financial statements which are the following:

● Balance Sheets
● Income Statement
● Statement of Cash Flow
● Statement of Changes in Owner’s Equity
● Notes to Financial Statements

As the major end-products of accounting, these statements carry the information about the
financial activities of the business.

Knowledge of accounting is crucial, not only to the accountant but also to anybody who is
involved in business. This is why courses in accounting are required of all business students, whether
they major in this field or not. The success of anyone who is engaged in a field of business such as
financial management, general management, marketing, entrepreneurship, and taxation depends on his
ability to understand, interpret and use the information contained in financial statements. It is important for
beginners to look into and understand the ‘why’ of an accounting process and not just memorize the
‘how’.

Qualitative Characteristics of Useful Financial Information

The qualitative characteristics of useful financial information discussed in this chapter identify the types of
information that are likely to be most useful to the existing and potential investors, lenders and other
creditors for making decisions about the reporting entity on the basis of information in its financial report
(financial information).

If financial information is to be useful, it must be relevant and faithfully represent what it purports to
represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and
understandable.

1. Fundamental Qualitative Characteristics- are information traits that are necessary for the
information to be considered useful.

a. RELEVANCE - When is (financial) information useful? When it has the capacity to

influence decisions
○ Financial information is capable of making a difference in decisions if it has
predictive value, confirmatory value or both.
○ For example, if a company is considering whether to invest in a new factory, the
decision will be based on the cash flows generated by the factory. The expected
future cash flows are relevant to the decision. However, information about the
company's current financial position is not relevant to the decision and would not
influence the decision.
 ● MATERIALITY refers to the significance of an item or transaction in the context
of a company's financial statements. An item or transaction is considered
material if its omission or misstatement would affect the decisions of the users of
financial statements. For example, a $1,000 transaction may be immaterial for a
large company, but it may be material for a small company. Similarly, an error in
the financial statements that does not impact the decision-making of users may
be considered immaterial.

b. FAITHFUL REPRESENTATION - When is (financial) information useful? When it

presents what really happened
● Is there adequate disclosure? (Completeness)
● Is it fair without bias? (Neutrality)
● Is it accurate? (Free from errors)

There are two main types of financial representation: disclosure and recognition.

● Disclosure - financial information is presented in the footnotes or other

disclosures accompanying the financial statements
○ allows users to understand the assumptions and methods used in
preparing the financial statements.
○ For example, if a company has significant amounts of debt, this
information should be disclosed so that users can take it into account
when interpreting the financial statements.
● Recognition - financial information is presented in the financial statements
themselves.
○ allows users to see the financial information that is most important to
them.

2. Enhancing Qualitative Characteristics - help determine which of two ways should be used to
depict a phenomenon if both are considered to provide equally relevant information and an
equally faithful representation of that phenomenon.

a. COMPARABILITY
i. Users make decisions by choosing between alternatives.
ii. enables users to identify and understand similarities in, and differences among
items
iii. requires at least two items
iv. Consistency, although related to comparability, is not the same. Consistency
refers to the use of the same methods for the same items, either from period to
period within a reporting entity or in a single period across entities. Comparability
is the goal; consistency helps to achieve that goal.

b. VERIFIABILITY
i. Different knowledgeable and independent observers can reach consensus that a
particular depiction is a faithful representation. It can be either direct or indirect,
and it is necessary to disclose the underlying assumptions, methods of compiling
the information, and other factors and circumstances that support the
information.

c. TIMELINESS
i. having information available to decision-makers in time to be capable of
influencing their decisions
ii. However, some information may continue to be timely long after the end of a
reporting period because, for example, some users may need to identify and
assess trends.
 d. UNDERSTANDABILITY
i. financial information should be presented in a way that can be easily understood
by users who have a reasonable knowledge of business and economic activities

How to apply the fundamental qualitative characteristics?

First, identify an economic phenomenon, information about which is capable of being useful to
users of the reporting entity’s financial information.

Second, identify the type of information about that phenomenon that would be most relevant.

Third, determine whether that information is available and whether it can provide a faithful
representation of the economic phenomenon. If so, the process of satisfying the fundamental qualitative
characteristics ends at that point. If not, the process is repeated with the next most relevant type of
information.

How to apply the enhancing qualitative characteristics?

Enhancing qualitative characteristics should be maximized to the extent possible. However,

enhancing qualitative characteristics, either individually or as a group, cannot make information useful if
that information is irrelevant or does not provide a faithful representation of what it purports to represent.

Applying the enhancing qualitative characteristics is an iterative process that does not follow a
prescribed order. Sometimes, one enhancing qualitative characteristic may have to be diminished to
maximize another qualitative characteristic. For example, a temporary reduction in comparability as a
result of prospectively applying a new Standard may be worthwhile to improve relevance or faithful
representation in the longer term. Appropriate disclosures may partially compensate for non-
comparability.

Basic Accounting Concepts and Principles

BASIC ACCOUNTING CONCEPTS

1. Economic Entity or Accounting Entity Concept

- The personal transactions of the owner are separate from that of the business he or she
owns.

2. Accrual Basis of Accounting Concept

- Revenue is recorded when earned.
- Expenses are recorded when it happens.
- Regardless of when cash is received or paid

3. Going Concern Concept

- The company will continue operating indefinitely until the foreseeable future, and that
company closure is not imminent.

4. Monetary Unit Concept

- Transactions are expressed in a monetary unit of measure.

5. Time Period Concept

- Transactions are summarized and reported at regular time intervals.
● Calendar Year (January 1 - December 31)
● Fiscal Year (Any starting point + 12 months)
BASIC ACCOUNTING PRINCIPLES

Generally Accepted Accounting Principles or GAAP - Uniform set of accounting rules, procedures,
practices and standards that are followed in preparing the financial statements

When do we say that the principle is generally acceptable?

Criteria:

Relevant - it should be useful in making a decision

Objective - not influenced by personal bias
Feasible - it can be implemented without due complexity or cost

1. Cost Principle
- Amounts shown in financial reports are historical costs.

2. Full Disclosure Principle

- Sufficient information for informed judgements.

3. Matching Principle
- Matching revenue with expenses to know the profit of the business.

4. Revenue Recognition Principle

- Recognize revenue when goods are sold or services are rendered, regardless of cash
receipt.

5. Materiality Principle
- In accounting, materiality refers to the impact of an omission or misstatement of
information in a company’s financial statements on the user of those statements. If it is
probable that users of the financial statements would have altered their actions if the
information had not been omitted or misstated, then the item is considered to be material.

6. Conservatism Principle
- If there are two acceptable alternatives in a situation, choose the alternative that will
result in lesser income or resources.

7. Objectivity Principle
- Recording and reporting process should be performed with independence which is free
from bias.

References

https://www.youtube.com/watch?v=i_Q-Q2k0zRM&fbclid=IwAR11g839my0SJAIKylKz1PjLpZp-
i_jg1HKGz-r6vXzxorLaq7WDILaXySM
https://www.ifrs.org/content/dam/ifrs/publications/pdf-standards/english/2021/issued/part-a/conceptual-
framework-for-financial-reporting.pdf
https://www.youtube.com/watch?v=L-XNhcVJbME&list=PLuOIo_eARcceNuUHngNhiRNUFMGhhF-
zG&index=3
https://www.youtube.com/watch?v=fncMDDLnGPY
https://www.youtube.com/watch?v=fPOcUtfGtxQ&t=771s
https://www.youtube.com/watch?v=XBFdjorUc8o