The qualitative characteristics (1) of useful financial information discussed in this lesson identify (2) 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 (3) information in its financial report (financial information).
Qualitative Characteristics of Useful Financial Information
If financial information is to be useful, it must be relevant (4) and faithfully represent (5) what it purports (6) to represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.
Part One: Fundamental Qualitative Characteristics
The fundamental qualitative characteristics are relevance (4) and faithful representation (5).
Relevant financial information is capable of (7) making a difference in the decisions made by users. Financial information is capable of making a difference in decisions if it has predictive (8) value, confirmatory (9) value or both. Financial information has predictive value if it can be used as an input to processes (10) employed by users to predict (8) future outcomes. Financial information has confirmatory value if it provides feedback about (confirms (9) or changes) previous evaluations. The predictive value and confirmatory value of financial information are interrelated (11). Information that has predictive value often also has confirmatory value. For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, can also be compared with (12) revenue predictions for the current year that were made in past years. The results of those comparisons (12) can help a user to correct and improve the processes that were used to make those previouspredictions.
Financial reports represent economic phenomena (13) in words and numbers. To be useful, financial information must not only represent relevant phenomena, but it must also faithfully represent the substance (14) of the phenomena that it purports to represent. To be a perfectly faithful representation, a depiction (15) would have three characteristics. It would be complete, neutral and free from error.
(16) depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations.
A neutral (17) depiction is without bias (18) in the selection or presentation of financial information. Neutrality (17) is supported by the exercise of prudence. Prudence (19) is the exercise of caution when making judgements under conditions of uncertainty (20). The exercise of prudence means that assets and income are not overstated (21) and liabilities and expenses are not understated (22) . Equally, the exercise of prudence does not allow for the understatement (21) of assets or income or the overstatement (22) of liabilities or expenses. Such misstatements (23) can lead to the overstatement or understatement of income or expenses in future periods.
Free from error (24) means there are no errors or omissions (25) in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process. In this context (26), free from error does not mean perfectly accurate in all respects (27). 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 being an estimate (28), the nature and limitations of the estimating (28) process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate.
Part Two: Enhancing qualitative characteristics
Comparability (29), verifiability (30), timeliness (31) and understandability (32) are qualitative characteristics that enhance the usefulness of information that both is relevant and provides a faithful representation of what it purports to represent. The enhancing qualitative characteristics (33) may also 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.
Users’ decisions involve choosing between alternatives (34), for example, selling or holding an investment, or investing in one reporting entity or another. Consequently, information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date.
Verifiability helps assure (35) users that information faithfully represents the economic phenomena it purports to represent. Verifiability means that different knowledgeable (36) and independent observers (37) could reach consensus (38), although not necessarily complete agreement, that a particular depiction is a faithful representation. Verification (39) can be direct or indirect. Direct verification means verifying (39) an amount or other representation through direct observation (40) , for example, by counting cash (41). Indirect verification means checking the inputs to a model, formula or other technique and recalculating the outputs using the same methodology (42). An example is verifying the carrying amount of inventory by checking the inputs (quantities and costs) and recalculating the ending inventory (43) using the same cost flow assumption (44) (for example, using the first-in, first-out method) (45).
Timeliness means having information available to decision-makers in time to be capable of influencing their decisions. Generally, the older the information is the less useful it is. 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.
Classifying (46), characterising (47) and presenting information clearly and concisely makes it understandable (32).
Some phenomena are inherently (48) complex and cannot be made easy to understand. Excluding (49) information about those phenomena from financial reports might make the information in those financial reports easier to understand. However, those reports would be incomplete and therefore possibly misleading (50).
Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. At times (51), even well-informed and diligent users may need to seek the aid of (52) an adviser to understand information about complex economic phenomena.