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Financial accounting: Qualitative characteristics of financial statements

Updated on January 23, 2012
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Financial reporting aims to satisfy the information needs of a wide range of stakeholders and users. To ensure that financial statements are meaningful and useful to users, there are four primary attributes that they must possess. The four attributes are: understandability, relevance, reliability and comparability.


These four characteristics are the primary ones, but there are several other important attributes: neutrality, prudence, completeness, faithful representation and substance over form. The Accounting Framework defines qualitative characteristics of financial statements as “the attributes that make the information in financial statements useful to users.” The four principal attributes rely on fundamental accounting assumptions such as consistency and fair presentation.


Understandability


Financial statements can appear like a foreign language to those who are unfamiliar with it. However, a closer look at the layout, annotations and overall design of financial statements suggest that they are designed for users to understand them (if not interpret them comprehensively). Indeed, users should be able to get a clear idea of the performance and financial position of an enterprise by reading it.

In addition to the format and layout of the statement, understandability includes an explanation of terms used, policies, methods and assumptions adhered to in preparation of the statement. Although understandability is important, it is not an excuse to omit complex matters or information from financial statements.


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Relevance


Relevance is a key characteristic of information in many spheres; accounting is no exception. Information from financial statements is for users to make economic decisions. Therefore, it must be pertinent to those decisions. Relevant information does not only apply to the present, since information in financial statements should allow users to assess historic or future events. Materiality (whether the information affects the economic decisions of information users) and the nature of information are critical to ascertaining relevance in a financial accounting context.


Reliability


According to ACCA, "reliable" information does not contain errors that affect the economic decisions of users, nor is it biased or partial. This attribute is linked to faithful representation, since users should be able to treat with it as such. Users have confidence in reliable financial statements. Such statements are not misleading or deliberately constructed in a manner that could skew decisions or perception of the financial position or performance of an entity. It is worth noting that the importance of auditing is increasing because it reinforces reliability.


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Comparability


This attribute simply suggests that users should be able to compare an entity’s statements to previous statements from that entity (through time) and with the statements of other entities. Comparability increases the transparency of financial statements by facilitating this. Financial statements are not uniform, especially as different accounting methods might be employed among different organizations. However, a basic standard provides a platform for suitable comparisons.


Conclusion


It is important to know and understand the theoretical framework for accounting. Sometimes, accounting students ignore this in favor of methods. It is also noteworthy that sometimes a trade-off exists between or among these attributes (a classic example being prudence versus accruals). In such cases, a financial accountant usually exercises discretion in resolving such conflicts.


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