How internal and external users benefit from financial information
Nowadays the role of accounting is very important in business because it help the business to grow and expand. Accounting is the process of identifying, measuring, recording and communicating economic information. These steps help the manager to make financial decisions to improve their business. Internal users use financial information to plan, control and make decisions based on the situation and resources of business such as salary cost or cost of goods sold. Furthermore, the external users such as stockholders, suppliers and government's agency also need the financial report from the business such as General Purpose Financial Report (GPFR) or Special Purpose Financial Report (SPFR). In accounting information's conceptual framework, there are some qualitative characteristics which make information useful such as understandability, relevance, reliability and comparability. This essay will critical examine the characteristic of accounting information in regard to understandability, relevance, reliability and comparability.
The first important characteristic of accounting information to make it useful is understandability. Understandability means that "users of accounting information can be assumed that they have reasonable knowledge about economic activities and to be able to read a financial report" (Ahmed Riahi-Belkaoui, 2004, p186). By this assumption, the users of financial report must have reasonable degree of financial knowledge to help them to read the report. On the other hand, even though the users have responsibility for understanding financial report, the business must provide the understandable financial report. An example of this is there are many arguments against the new accounting method when the business want to replace the old systems because there will be many users of financial report who can not adapt to understand the new accounting method. As a result, the financial report will be useless even though the new method is more useful for decision making. The argument also state that the "understandability is more important than relevant". However, the business nowadays is very complex, so that the users must have some advisers to read the financial reports for them if they have difficulty to read the reports. For example, the capital providers are unfamiliar with actions the entity will take to hedge its exposure to financial risks so that they will have difficulty to understand the financial statement which explain the exposure activities. This information, however is relevant to users who making the decisions (Financial accounting standard board, 2008). Finally, the users of accounting information must have reasonable knowledge about financial activities and able to read the accounting report. Moreover, the financial report is useful when it is understandable for the users.
Relevant also is a very important characteristic of accounting information because it is the first primary qualitative characteristics of Hierarchy of Desirable Characteristics of Accounting Information (no author, 2007). Relevance is defined when the information "is usefully associated with the action it is designed to facilitate or the result it is designed to produce" (Walter B. Meigs, 1979, p37). Therefore, relevant information can affect manager's decisions by changing or confirming their decisions about the result of activities or events. There are 3 components of relevance which are predictive value, feedback value and timeliness. In the accounting's conceptual framework, relevant information is useful for the investors, creditors to evaluate the past, present and future of activities (predictive value) and to confirm their decision (feedback value). The relevant information also has timeliness because the relevant information will reduce their usefulness if the decision makers would not be made within the time limit. In conclude, the relevant information is very useful for the users because they can make the decisions based on the past, present and future of activities.
Thirdly, accounting information will not be useful without reliability. Reliability in accounting information is defined as the information is "truthful, accurate, complete and capable of being verified" (Wikianswers, 2008). The reason why accounting information should be reliable is that the users will rely on the information to make decisions. There are three component characteristics in reliability which are verifiability, representational faithfulness and neutrality. The accounting must be verified to confirm the accuracy of information so they can audit or change the information. Moreover, the representational faithfulness is defined as the agreement between the measure and actual events, so that the information will be truthful and accurate. Furthermore, the last component characteristic of reliability is neutral. Neutral information is "free from bias toward attaining some desired result or inducing a particular mode of behavior" (Ahmed Riahi-Belkaoui, 2004, 187) which means that the purport of the information should be affected from predetermined results. Finally, if the information does not have reliability, the business can not make decisions based on the information or they may make inappropriate decision which will lead to the negative result.
The last characteristic of accounting information is comparability which is also the secondary quality. Comparability is simply allows the business or users of information to make a comparison between the variable information. For example, there are three companies which using different method to calculate the depreciation. The first two companies using straight line method, whereas the last one using "accelerated" depreciation method. As a result, the users of information hardly make a decision based on the result because three companies using different method. It should be easier if three companies using the same method to calculate the depreciation (Ahmed Riahi-Belkaoui, 2004, p187). Consistency is different from comparability because consistency means that the financial statement can be compared within a single company from one accounting's period to the next. For example, the company may want to change the accounting's system, so that it is hard to compare the information in two periods because they are using different accounting method. Therefore, the accounting information should be comparable, so that the users can make decisions about the future by comparing the past's information and the present's.
In conclusion, the accounting information will be useful to the users when they have four characteristics which are understandability, relevance, reliability and comparability. Understandability means that the accounting information should be reported in common ways, so that the users who actually have knowledge about reading accounting report will understand the report. Furthermore, the accounting information should be relevant, so that the users can make future's decisions based on the past and the present. In addition, reliability also seems to be very important characteristics of accounting information because if the information is inaccurate or untruthful will lead to wrong decisions. Lastly, the accounting information should be comparable so that the users can compare the information every year to make the appropriate decisions. Therefore, accounting information is very important for the users because it will affect the business, and accounting is needful nowadays.
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