QUALITATIVE

CHARACTERISTICS
CHAPTER 3
QUALITATIVE CHARACTERISTICS
• Qualitative characteristics are the qualities or attributes that make
financial accounting information useful to the users
WHAT INFORMATION TO INCLUDE IN FS
• The objective is to ensure that the information is useful to the users
in making economic decisions.
CLASSIFICATION OF QUALITATIVE
CHARACTERISTICS
FUNDAMENTAL QUALITATIVE ENHANCING QUALITATIVE
CHARACTERISTICS CHARACTERISTICS

Relate to the content or substance Relate to the presentation or form

of financial information of the financial information

1. Relevance 1. Comparability
2. Faithful representation 2. Understandability
3. Verifiability
4. Timeliness
APPLICATION OF 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
FUNDAMENTAL QUALITATIVE
CHARACTERISTICS
FUNDAMENTAL QUALITATIVE
CHARACTERISTICS
1. RELEVANCE
2. FAITHFUL REPRESENTATION
1. RELEVANCE
• 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
• Relevance requires that the financial information should be related or
pertinent to the economic decisions
• Examples:
• The statement of financial position is relevant in determining financial
position, and the income statement is relevant in determining performance
• The EPS information is more relevant that book value per share in
determining the attractiveness of an investment
INGREDIENTS OF RELEVANCE
A. PREDICTIVE VALUE
B. CONFIRMATORY VALUE
1.A PREDICTIVE VALUE
• Financial information has predictive value if it can be used as an
input to processes employed by users to predict future outcome
• Help users increase the likelihood of correct or accurately
predicting or forecasting outcome of events

• Example: information about financial position and past

performance is frequently used in predicting dividend and wage
payments and the ability of the entity to meet maturing
commitments
1.B CONFIRMATORY VALUE
• Financial information has confirmatory value if it provides feedback
about previous evaluations
• Enables users confirm or correct earlier expectations

• Example: a net income measure has confirmatory value if it can help

shareholders confirm or revise their expectation about an entity’s
ability to generate earnings
REMEMBER
• The predictive and confirmatory roles of information are
interrelated.

• Example:
• Interim income statement which provides feedback about income to
date and serves as a basis for predicting the annual income.
• The interim income statement for the first quarter shows net income of
P2,000,000. – Confirmatory value
• If trend continues for the entire year, it is logical to assume that the net
income after four quarter would be P8,000,000 – Predictive value
MATERIALITY
• Materiality is a subquality of relevance based on the nature or
magnitude or both of the items to which the information relates
• 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
statements.
• MATERIALITY CONCEPT – also known as the doctrine of convenience
• Materiality is really a quantitative threshold linked very closely to the
qualitative characteristic of relevance
• The relevance of information is affected by its nature and materiality
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

• Example:
• An error of P500,000 in the financial statements of a multinational
entity may not be important but may be so critical for a small
entity.
WHEN IS AN ITEM MATERIAL?
GENERAL GUIDE: 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 DEFINITON OF MATERIALITY
Information is material if An information is material if
omitting, misstating or the omission, misstatement
obscuring it could reasonably and obscuring of the
be expected to influence the information could reasonably
economic decisions that affect the economic decision
primary users of general of primary users.
purpose financial statements
make on the basis of those
statements which provide
financial information about a
specific reporting entity.
COULD REASONABLE BE EXPECTED TO
INFLUENCE
• The could reasonably be expected to influence threshold adds an
element of reasonability of financial information on which economic
decision is based.
• Material information shall be limited to the economic decision of
primary users rather than to all users which is too broad in scope.
• Insures that information capable of influencing economic decision of
the primary users shall be included in the financial statements.
OBSCURING INFORMATION
• Information is obscured if presenting or communicating it would have
a similar effect as omitting or misstating the information.
• The presentation of financial information not readily understood or
not clearly expressed.
• Deliberate vagueness, ambiguity and abstruseness.
EXAMPLE OF OBSCURED MATERIAL
INFORMATION
• The language is vague or unclear
• The information is scattered throughout the financial statements
• Dissimilar items are aggregated inappropriately.
• Similar items are disaggregated inappropriately.
PRIMARY USERS
• The new definition specified that only primary users of financial
statements are considered because these groups are the users to
whom general purpose financial statements are primary directed.
FACTORS OF MATERIALITY
• Materiality depends on the magnitude and nature of the financial
information.
• The relative size and nature of an item are considered
FACTORS OF MATERIALITY
SIZE OF THE ITEM in relation to
the total of the group to which
the item belongs is taken into
account.
NATURE OF THE ITEM may be
inherently material because by
its very nature it affects
economic decision.
EXAMPLE:
The amount of advertising in relation
to total selling expenses.
The amount of office salaries to total
administrative expenses.
EXAMPLE:
The discovery of a P20,000 bribe is a
material event even for a very large
entity.
2. FAITHFUL REPRESENTATION
• Financial reports represent economic phenomena or transactions in
words and numbers
• Descriptions and figures must match what really existed or happened.

EXAMPLE:
1. If the entity reports purchases of P5,000,000 when the actual
amount is P8,000,000, the information would not be faithfully
represented.
2. To record a sale of merchandise as miscellaneous income would not
also be a faithful representation of the sale transaction.
INGREDIENTS OF FAITHFUL REPRESENTATION
A. Completeness
B. Neutrality
C. Free from error
2.A COMPLETENESS
• Requires that relevant information should be presented in a way that
facilitates understanding and avoids erroneous implications.
• A complete depiction includes all information necessary for a user to
understand the phenomenon or transaction being depicted, including
all necessary description and explanation.
• The financial statements shall be accompanied by notes to financial
statements.
• PURPOSE OF NOTES: to provide the necessary disclosures required by
PFRS.
STANDARD OF ADEQUATE DISCLOSURES
• Completeness is the result of the standard of adequate disclosure or
principle of full disclosure.
• standard of adequate disclosure – all significant and relevant
information leading to the preparation of financial statements shall
be clearly reported.
• Disclosure of any financial facts significant enough to influence the
judgement of informed users.
• The accountant shall disclose a material fact known to him which is
not disclosed in the financial statements but disclosure of which is
necessary in order that the financial statements would not be
misleading.
2.B NEUTRALITY
• Neutral depiction is without bias in the preparation or presentation of
financial information.
• A neutral depiction is not slanted, weighted, emphasized, de-emphasized
or otherwise manipulated to increase the probability that financial
information will be received favorably or unfavorably by users.
• To be neutral, the information contained in the financial statements must
be free from bias.
• The financial information should not favor one party to the detriment of
another party.
• To be neutral is to be fair.
PRUDENCE
• 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
• Conservatism means that when alternatives exist, the alternative which has
the least effect on equity should be chosen.
• Simply stated, in case of doubt, record any loss and do not record any gain.
• It is to be emphasized that conservatism is not a license to deliberately
understate net income and net assets.

EXAMPLE:
1. Inventories are measured at the lower of cost and NRV.
2. Contingent loss is recognized as a “provision” if the loss is probable and
the amount can be reliably measured. Contingent gain is not recognized
but disclosed only.
2.C FREE FROM ERROR
• There are no errors or omissions in the description of the phenomenon or
transaction.
• Process used to produce the reported information has been selected and
applied with no errors in the process.
• Free from error does not mean perfectly accurate in all respects.

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.
MEASUREMENT UNCERTAINTY
• Arises when monetary amounts in financial reports cannot be
observed directly and must instead be estimated.
• Can affect faithful representation if the level of uncertainty in
providing an estimate is high.
• As long as the estimate is clearly and accurately described and
explained, even a high level of measurement uncertainty does not
affect the usefulness of the financial information.
SUBSTANCE OVER FORM
• The transactions and events are accounted in accordance with their
substance and not merely their legal form.
• Substance over form is not considered a separate component of
faithful representation because it would be redundant.
• Faithful representation inherently represents the substance of an
economic phenomenon or transaction rather than merely
representing the legal form.
ENHANCING QUALITATIVE
CHARACTERISTICS
ENHANCING QUALITATIVE CHARACTERISTICS
1. COMPARABILITY
2. UNDERSTANDABILITY
3. VERIFIABILITY
4. TIMELINESS
1. COMPARABILITY
• The ability to bring together for the purpose of noting points of
likeness and difference.
• Enables users to identify and understand similarities and
dissimilarities among items.
• For information to be comparable, like things must look alike and
different things must look different.

2 types
A. Comparability within an entity
B. Comparability between and across entities
1.A COMPARABILITY WITHIN AN ENTITY
• The quality of information that allows comparisons within a single
entity through time or from one accounting period to the next.
• Also known as horizontal comparability or intracomparability
1.B COMPARABILITY BETWEEN AND ACROSS
ENTITIES
• The quality of information that allows comparisons between two or
more entities engaged in the same industry.
• Also known as intercomparability or dimensional comparability.
CONSISTENCY
• Implicit in the quality characteristic of comparability is the principle of
consistency.
• Not the same as comparability
• Consistency is desirable and essential to achieve comparability of financial
statements.
• Consistency does not mean that no change in accounting method can be
made.
• If the change would result to more useful and meaningful information,
then such change shall be made with full disclosure of the change and the
peso effect.
• It is inappropriate for an entity to leave accounting policies unchanged
when better and acceptable alternatives exist.
CONSISTENCY vs COMPARABILITY
CONSISTENCY
Consistency refers to the use of the
same method for the same item, either
from period to period within an entity or
in a single period across entities.
Consistency is the uniform application of
accounting method from period to
period within a entity.
COMPARABILITY
Comparability is the goal and
consistency helps to achieve that goal.
Comparability is the uniform application
of accounting method between and
across entities in the same industry.
2. UNDERSTANDABILITY
• Requires that the financial information must be comprehensible or
intelligible if it is to be most useful.
• The information should be presented in a form and expressed in
terminology that a user understands.
• Classifying, characterizing and presenting information “clearly and
concisely” makes it understandable.
• The users shall have an understanding of the complex economic
activities, the financial accounting process and the terminology in the
financial statements.
2. UNDERSTANDABILITY
• Financial reports are prepared for users who have a reasonable
knowledge of business and economic activities and who view and
analyze the information diligently.
• At times, even well-informed and diligent users may need to seek the
aid of an adviser to understand information about complex
phenomena or transactions.
• Understandability is very essential because a relevant and faithfully
represented information may prove useless if it is not understood by
users.
3. 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 it is supported by
evidence so that an accountant that would look into the same evidence
would arrive at the same economic decision or conclusion.
• Verifiable financial information provides results that would be substantially
duplicated by measurers using the same measurement method.
• Verifiability helps assure users that information represents the economic
phenomenon or transaction it purports to represent.
• Synonymous with objectivity
TYPES OF VERIFICATION
A. DIRECT
B. INDIRECT
3.A DIRECT VERIFICATION
• Means verifying an amount or other representation through direct
observation, for example, by counting cash
3.B INDIRECT VERIFICATION
• Means checking the inputs to a model, formula or other technique
and recalculating the inputs using the same methodology.
4. TIMELINESS
• Means that financial information must be available or communicated early
enough when a decision is to be made.
• Relevant and faithfully represented financial information furnished after a
decision is made is useless or of no value.
• Generally, the older the information, the less useful.
• However, some information may continue to be timely along after the end
of reporting period because some users may need to identify and assess
trends.
• Timeliness enhances the truism that without knowledge of the past, the
basis for prediction will usually be lacking and without interest in the
future, knowledge of the past is sterile.
• What happened in the past would become the basis of what would happen
in the future.
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.
• The cost constraint is a consideration of the cost incurred in
generating financial information against the benefit to be obtained
from having the information.
• The benefit derived from the information should exceed the cost
incurred in obtaining the information.