The qualitative characteristics of financial information refer to the attributes that make it useful for decision-making purposes.
These characteristics include relevance, reliability, comparability, consistency, understandability and timeliness. The qualitative characteristic of financial information is to identify the most useful information to investors (existing and potential), lenders and other creditors for making their decision based on the financial report.
In order for the financial statements to be relevant to the stakeholders of a corporation, they must reflect specific qualitative qualities. These features are divided into two sections i.e. essential qualitative characteristics and increasing qualitative attributes.
In this article, we will explore each of these characteristics in detail and discuss why they are important for users of financial information.
Table of Contents
There are only two qualitative characteristics of financial information, and those are relevance and faithful representation. These two characteristics are necessary in order for the financial information to be deemed useful.
If certain financial data can influence or make a difference in the decision-making process, it can be regarded as relevant. Additionally, the financial data must be material and must have either confirmatory, predictive, or both qualities in order to be relevant. Every relevant piece of information for a particular business should be included in a financial report. Financial data should accurately represent the things it is intended to represent, according to the principle of faithful representation. This representation suggests that the financial data is thorough, impartial, and devoid of errors.
The information should be relevant to the demand of the users. The appropriate financial information assists the readers of the financial statements in making a different economic choice. Financial information needs to be predictive, informative, or both for financial decision-making. Predictive Values aid users in forecasting future results. On the other hand, confirmatory values assist users in examining and validating predictions and judgments. Materiality is also included as an element of relevance.
ii. Faithful Representation
One of the fundamental qualitative characteristics is a faithful representation. The information in the financial statement must be reliable, i.e. the information should be free of material errors and biases (Nobes & Stadler, 2015). The data should not be misstated. The source of information should be authentic, and the transactions should be represented faithfully. The same should not be misled
Enhancing Qualitative Characteristics
The enhancing qualitative characteristics of financial information are comparability, verifiability, timeliness, and understandability. Users of financial statements must be able to compare elements of an entity at one time and over time, as well as between entities at one time and over time. When it comes to comparability it allows the users to identify similarities and differences. Verifiability The different knowledgeable and independent observers could reach essentially similar conclusions.
One way to enhance comparability is to provide more information about the items on the financial statements. For example, instead of just providing the total amount of sales for the year, entities can provide a breakdown of sales by product type or geographical region. This type of information helps users understand how the entity is performing and compare it to other entities.
Another way to enhance comparability is to improve the disclosure of accounting policies. This information helps users understand how the information on the financial statements has been prepared and compared to other entities with different accounting policies. For example, if two entities have different policies for depreciating their equipment, users will be able to understand the impact of this difference on the financial statements.
Verifiability can be enhanced by improving the disclosures in the financial statements. For example, when reporting inventory, entities can disclose the methods used to count the inventory and the policies for valuing the inventory. This information helps users understand how the information has been prepared and confirm that it accurately represents the underlying transactions.
In addition, enhancing the disclosures in the notes to the financial statements can also improve verifiability. For example, disclosing the assumptions used in preparing the financial statements helps users to understand the information and to verify that it is free from material error.
Timeliness can be enhanced by providing more current information. For example, entities can provide interim financial statements every quarter instead of annually. This information helps users to make informed decisions promptly.
In addition, entities can improve the disclosure of information about events that occur after the balance sheet date but before the financial statements are issued. For example, entities can disclose information about signing contracts that have been signed but not yet completed. This information helps users understand these events’ impact on the financial statements.
Information presented in the financial statements should be understandable to those who want to review and use it. This can be facilitated through appropriate classification, characterisation and presentation of information.
Understandability can be enhanced by providing clear and concise disclosures in financial statements. For example, entities can use graphs and charts to present information in a way that is easy to understand. In addition, the notes to the financial statements can be written in clear and concise language.
The two fundamental qualitative characteristics of financial information are relevance and faithful representation. A financial statement that is irrelevant or unfaithful and represents what it purports to represent will be useless as a decision-making tool.
The four enhancing qualitative characteristics of financial information are comparability, verifiability, timeliness, and understandability. These cannot take the place of fundamental qualitative characteristics for these four only improve the usefulness of the relevant and faithfully represented information.