CONCEPTUAL FRAMEWORK 2

QUALITATIVE CHARACTERISTICS
Qualitative characteristics are the qualities or attributes that make financial accounting
information useful to the users.
In deciding which information to include in the financial statements, the objective is to
ensure that the information is useful to the users in making economic decisions.
Under the Conceptual Framework for Financial Reporting, qualitative characteristics are
classified into fundamental qualitative characteristics and enhancing qualitative characteristics.
FUNDAMENTAL QUALITATIVE CHARACTERISTICS
The fundamental qualitative characteristic relate to the content or substance of the financial
information, it consist of relevance and faithful representation. Thereby making financial
statements be represented with relevance and faithful representation, both must be present to aid
decision making process.
Application of Qualitative Characteristics
The most efficient and effective process of applying the fundamental qualitative
characteristics would usually be:
1. Identify an economic phenomenon that has potential to be useful.
2. Identify the type of information about the phenomenon that would be most relevant can be
faithfully represented.
3. Determine whether the information is available
Relevance
In the simplest term, relevance is the capacity of the information to influence a decision.
To be relevant, the financial information must be capable of making a difference in the decisions
made by users. Which leads us to conclude that financial information should be related to the the
economic decision, otherwise, the information is considered useless.
For example, broadly, the statement of financial position is relevant in determining
financial position, and the income statement is relevant in determining performance. To be
specific, the earnings per share of a company is relevant towards investors than book value per
share.
Ingredients of Relevance
Financial information is capable of making a difference in a decision if it has predictive
value and confirmatory value of which the two are ingredients of relevance.
• Predictive Value – Financial information has predictive value if it can be used as an input
to processes employed by users to predict future outcome. In other words, financial
 information has predictive value when it can help users increase the likelihood of correctly
or accurately predicting or forecasting outcome of events.
An example would be, information about financial position has past performance
is frequently used in predicting dividend and wage payments and the ability of the entity
to meet maturing commitments. The net cash provided by operating activities is valuable
in predicting loan payment or default.
• Confirmatory Value – Financial information has confirmatory value if it provides feedback
about previous evaluations. In other words, financial information has confimatory value
when it enables users to confirma or correct earlier expectations. For example, a net infome
measure has a confirmatory value fi it can help shareholders confirm or revise their
expectation about an entity’s ability to generate earnings.
Often information has both predictive value and confirmatory value, they are usually
interrelated. An example is an enterim income statement which provides feedback about income
and to date and serve as a basis for predicting the annual income. The interim income statement
for the first quarter shows net income of P2,000,000. This is confirmatory value. If this trend
continues for the entire year, it is logical to assume that the net income after four quarters or one
year has P8,000,000. This is predictive value.
Materiality
Materiality is a practical rule in accounting which dictates that strict adherence to GAAP
is not required when the items are not significant enough to affect the evaluation, decision and
fairness of the financial statement.
The materiality concept is also called as doctrine of convenience.
Materiality is really a quantitative threshold linked very closely to the qualitative
characteristics of relevance. The relevance of information is affected by its nature and materiality.
Which makes materiality a subquality of relevance based on the nature or magnitude or both of
the items to which the information relates.
The Conceptual Framework does not specify a uniform quantitative threshold for
materiality or predetermine what could be material in a particular situation.
Materiality is a relativity. Materiality of an item depends on relative size rather than
absolute size. What is material for one entity may be immaterial for another. An error of P500,000
in the financial statement of a multinational company may be important but may be so critical for
a small company.
The general guide in determining materiality is “an item is material if knowledge of it could
reasonably affect or influence the economic decisions of the primary users of the financial
statements.”
New definition of materiality
The IASB provided the following new definition of materiality.
“Information is material if omitting, misstating, or obscuring it could reasonably be
expected to influence the economic decisions that primary users of general-purpose financial
statements make on the basis of those statements which provides financial information about a
specific reporting entity.”
In other words, an information is material if the omission misstatement and obscuring of
the information could reasonably affect the economic decision of primary users.
The definition highlights 3 aspects:
• Could reasonably be expected to influence – this adds an element of reasonability of
financial information on which economic decision is based.
• Obscuring information – information is obscured if presenting or communicating it
would have similar effect as omitting or misstating the information. Specifically, it means
that the presentation of financial information not readily understood or clearly express.
Obscuring information extends as to “deliberate vagueness, ambiguity, and abstruseness.
Some examples are, language is vague or unclear, the information is scattered throughout
the financial statements. Dissimilar items are aggregated inappropriately.
• Primary users – are those who are primarily affected by general purpose financial
statements, specifically, lenders and other creditors, and existing and potential investors.
Factors of Materiality
Materiality depends on the magnitude and nature of the financial information.
Magnitude or size of an information in a sense that in relation to the total group to which
the item belongs to an account. For example that P100,000 pesos unrecorded expenses is not
material to large company but critical to a small company.
Nature may be inherently material because by its nature it affects economic decision. For
example, a P20,000 bribe is material even as to large company.
Faithful Representation
Faithful representation means that financial reports represent economic phenomena in
words and numbers. Stated differently, the description and figures must match to what really
existed or happened. In a simple manner, it means that the actual effect of transactions shall be
properly accounted for and reported in the financial statements. For example, an actual purchase
of P5,000,000 is reported as P8,000,000 is not faithfully represented, and presenting sales as
miscellaneous income is also not faithfully presented.
Ingredients of Faithful Representation
For an information to be perfectly represented, it must have 3 characteristics, name:
a) Completeness – requires relevant information should be presented in a way that facilitates
understanding and avoids erroneous implication.
Completeness is the result of the adequate disclosure standard or principle of full
disclosure. The standard of adequate disclosure means that all significant and relevant
information leading to the preparation of financial statements shall be clearly reported.
Adequate disclosure however does not mean disclosure of any data hence, ”The standard
adequate disclosure is best described by disclosure of any financial facts significant enough
to influence the judgement of informed users”
Actually, to be complete, the financial statements shall be accompanied by “notes
to financial statements”. The purpose of the notes is to provided necessary disclosures
required by Philippine Financial Reporting Standard.
b) Neutrality – a neutral depiction is without bias in the preparation or presentation of
financial information. The financial information should not favor one party to the detriment
of other party. To be neutral is to be fair.
Prudence is 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 or
expenses are not understated. Neutrality is supported by the exercise of prudence.
Conservatism is synonymous with prudence. Conservatism mean that when an
alternate exist, the alternative which has the least effect on equity should be choses. In
simplest words, conservatism means “in case of doubt, record any loss and do not record
any gain”.
c) Free from error – means that there are no errors or omissions in the description of the
phenomenon or transaction. Moreover, the process used to produce the reported
information has been selected and applied with no errors in the process.
In this context, free from error does not mean perfectly accurate in all respects. For
example, an estimate of an unobservable price or value cannot be determined to be accurate
or inaccurate. However, a representation of that estimate can be faithful if the amount is
described clearly and accurately as an estimate. The nature and limitations of the estimating
process must be explained and no errors have been made in developing the estimate.
Measurement uncertainty arises when monetary amounts in financial reports
cannot observed directly and must be instead be estimate. It usually affect faithful
representation, but since reasonable estimate is essential in providing financial information,
the said statement is faithfully represented as long as the estimate is clearly and accurately
described and explained.
If the information is to represent faithfully the transactions and other events it
purports to represent, it is necessary that the transaction and events are accounted in
accordance with their substance and realityand not merely their legal form, hence
Substance over form.
ENHANCING QUALITATIVE CHARACTERISTICS
The enhancing qualitative characteristics related to the presentation or form of the financial
information. It is aimed to increase the usefulness of the financial information that relevant and
faithfully represented.
The enhancing qualitative characteristics are:
a) Comparability – means the ability to bring together for the purpose of noting points of
likeness and difference. Comparability may be made within an entity or between and across
an entity.
Intracomparability or comparability within an entity is the comparison of
information from one accounting period to another.
Intercomparability or comparability between and across an entity is the
comparison of information from one company to another under the same industry.
Implicit in the qualitative characteristics of comparability is the principle of
consistency. Consistency is not the same as comparability. Consistency is the uniform
application of accounting method from period to period within the entity. On the other
hand, comparability is the uniform application of accounting method between and across
entities in the same industry. Comparability is the goal and consistency is the help to
achieve the goal.
However, consistency does not mean that no change in accounting methods can be
made. If the change would result to more useful and meaningful information, then such
thing can be made. But there shall be full disclosure of the change and the peso effect
thereof. It is inappropriate for an entity to leave accounting policies unchanged when better
and acceptable alternatives exist.
b) Understandability – understandability requires that financial information must be
comprehensible or intelligible if it is most useful or in other words, must be expressed that
user will understand.
Financial statements cannot be realistically be understandable to everyone, so the
users are expected to have reasonable knowledge of business and economic activities in
order to fully utilize the financial statements
c) Verifiability – means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a
faithful representation. Verifiability implies consensus, the financial information is
verifiable in the sense that is is supported by evidence would arrive at the same economic
decision or conclusion. Verification can be direct or indirect.
Direct verification means verifying an amount or other representation through
direct observation i.e., cash counting.
Indirect verification means checking inputs to a model or formula or other
technique and recalculation the inputs using the same methodology i.e., methods in
inventory valuation.
 d) Timeliness – Timeliness means that the financial information must be available or
communicated early enough when a decision is to be made.
Cost constraint on useful information
Cost is a pervasive constraint on the information that can be provided by financial
reporting. Reporting financial information imposes cost and it is important that such cost is
justified by the benefit derived from the financial information. Hence, “The benefit derived from
the information should exceed the cost incurred in obtaining information”.