What are the important Qualitative characteristics of Financial Statements?

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As we understand that different users require financial information for assistance in their economic decisions. Entities publish financial statements so that users can get their information needs fulfilled.

The dependence of users’ economic decision on financial statements is crucial and if the financial information is not accurate or is not true and fair then users may end up making wrong decisions. Therefore, financial statements need to have certain qualitative characteristics in order to be useful to its users.

IASB Framework for Presentation and Preparation of Financial Statements states FOUR principal characteristics as follows:

  1. Understandability
  2. Relevance
  3. Reliability
  4. Comparability

Understandability

Users cannot use such financial information that they cannot understand. Problems in understanding may arise due to user’s inabilities or because of the information itself. Definitely entity cannot do anything about users and its upon the user to have at basic level of understanding about financial statements. Also, users are not required to be professional accountants and that is why where we expect to have complex information then its neither fault on part of user nor from the side of the entity preparing financial statements.

However, entity can present information in such a manner that it helps in understanding. Also with proper explanation financial statements can be made more understandable. Therefore, entity is required to take reasonable measures in order to make financial statements easy to understand. However, it does not mean that complex information which is also of material nature should be excluded from the financial statements on the basis that it is creating problems in overall understandability of financial statements.

Relevance

Information is considered relevant which adds value to the decision making process by providing the required bits and pieces of past, preset and future times. Through relevant information users can evaluate whether they are moving along the right path i.e. making correct decisions.

Information is also said to be relevant when it is capable of confirming or correcting the existing thought process and information.

Many students might think that financial statements always relates to past (financial period that have already passed) then how come past information can help us in making decisions? Well to give you a simple example, we all use our experience to decide about something and certainly experience is always what we already know from the past. Same way, past information given in financial statements help us in predicting the financial position and financial performance of the company in upcoming financial periods. So, even past information can be relevant.

Reliability

Information is reliable when it is dependable and this is possible if it is:

  • free from errors, especially material errors
  • complete
  • free from bias

Information may be relevant but this alone does not suffice for reliability as well. Information must be reliable as well as relevant in order to be useful for decision making. There are many other factors that contribute towards the reliability of the financial information.

Comparability

Comparability of information refers to its ability to stand useful overtime and against the financial information from other sources. Users cannot evaluate different aspects of entity’s financial position and financial performance if they are unable to compare the financial information of one period with another or financial information of one entity with another entity’s financial information.

In order to have comparable information entities prepare there financial statements by following a uniform pattern of presentation which is usually as instructed by the International or Local Accounting Standards and after they adopt a particular style they remain consistent in its application.

However, comparability does not require that one stays uniform even if there are other ways to make financial statements even more reliable and relevant.

By the above discussion we can observe one fact that all four principal characteristics are interrelated and higher level is achieved in one area at the expense of the other. For example, in order to make financial statements more reliable entity may include such financial information which is complex thus higher level of reliability is achieved at the expense of understandability.

It is the responsibility of the management to have an optimum mix of all four important qualitative characteristics of financial statements

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