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In SFAC2, relevance and reliability are included as the primary decision-specific qualities, others as the components of these, and comparability including consistency as the secondary qualities, whereas, in SFAC8, relevance and faithful representation are the fundamental qualitative characteristics, and comparability, verifiability, timeliness, and understandability as the enhancing qualities.
The main finding in this report is the accounting qualities in SFAC8 have significant improvement over the previous hierarchy of accounting qualities in SFAC2.
In 1980, the Financial Accounting Standards Board (FASB) has issued a pronouncement entitled Statement of Financial Accounting Concepts No.2 (SFAC2). This was designed to depict the qualitative characteristics of financial information and to guide in the consistency of accounting standards.
In 2004, the FASB and International Accounting Standards Board (IASB) announced that they were starting a project to product a joint conceptual framework (CF). In 2010, a new joint CF has been developed, which includes Chapter 1 on 'Objectives' and Chapter 3 on 'Qualitative Characteristics'. FASB has published these chapters as their new Statement of Financial Accounting Concepts No.8 (SFAC8) and replaced the SFAC1 and SFAC2. IASB also published these chapters into their CF.
The purpose of this report is to compare and contrast, thus analyse, the similarities and differences between the qualitative characteristics in SFAC2 and SFAC8. Besides, the report also assesses the arguments put forward to the qualitative characteristics before the joint CF has been developed. Then, it will conclude on whether the 30 years' development of ideas has resulted in a better treatment of qualitative characteristics.
2. Main body
2.1 SFAC2 vs. SFAC8
According to FASB (1980:par33), to be useful for decision making, accounting information must possess the two primary qualities, which are relevance and reliability. On the other hand, according to FASB (2010:QC5), financial information to be useful, it must have two fundamental qualitative characteristics, which are relevance and faithful representation. Both SFAC2 and SFAC8 state that information to be relevant must be capable of making a difference in decisions of the user.
In SFAC2 (1980:par33), predictive value, feedback value and timeliness are the components qualities of relevance, whereas, in SFAC8 (2010:QC7), predictive value and confirmatory value are the components qualities of relevance. Both SFAC2 (1980:pg10) and SFAC8 (2010:QC8) claim that the information which can help user to forecast future outcome has the quality of predictive value. According to SFAC2 (1980:pg10), feedback value is the quality which enables users to confirm or correct the prior predictions. Therefore, feedback value has been replaced by confirmatory value in SFAC8.
SFAC2 (1980:par56) identifies timeliness as a components quality of relevance and defines it as the availability of having information for decision makers before losing the power to change decisions. However, in SFAC8 (2010:QC19), timeliness is one of the enhancing qualities for the two fundamental qualitative characteristics.
In SFAC2 (1980:par33), the term reliability is used, whereas, in SFAC8 (2010:QC4), faithful representation is another fundamental qualitative characteristic. SFAC2 (1980:par33) includes verifiability, neutrality and representational faithfulness as the components quality of reliability. In addition, representational faithfulness consists of effects of bias and completeness (FASB, 1980:par78&80). According to SFAC8 (2010:QC12), economic phenomena to be perfectly faithful representation, it must be complete, neutral, and free from error. Now, reliability has been replaced by faithful representation. Both SFAC2 and SFAC8 include neutrality as a component quality.
SFAC2 (1980:par95) mentions about conservatism, which is a prudent reaction to uncertainty. However, there is a preference for understatement of net income and net assets instead of overstatement (FASB, 1980:par92). Besides, conservatism is conflict with the qualitative characteristics, such as neutrality which include free from bias (FASB, 1980:par92). Therefore, SFAC2 does not include conservatism as a qualitative characteristic as well as SFAC8.
In SFAC8 (2010:QC19), comparability, verifiability, timeliness and understandability are now enhancing qualities for the two fundamental qualitative characteristics. SFAC2 (1980:par116) implies comparability as a secondary quality to the primary qualities because comparability is a quality of the relationship between the relevance or reliability of information, whereas, SFAC8 (2010:QC24) states that the economic phenomenon with the fundamental qualitative characteristics should possess some degree of comparability, and thus comparability is an enhancing quality.
SFAC2 (1980:par81) identifies verifiability as a component of reliability and mentions the objective of verification is to provide assurance of the information. On the other hand, SFAC8 (2010:QC26) states that verifying information can help users to assure the economic phenomenon with the fundamental qualitative characteristics, and thus verifiability is an enhancing quality.
Both SFAC2 and SFAC8 include understandability as a qualitative characteristic. The more understandable the information is, the more benefits of information will increase, and hence the more useful the information is to users (FASB, 1980:par40). Therefore, SFAC8 (2010:QC19) includes understandability as an enhancing quality. Besides, SFAC8 (2010:QC32) also mentions that diligent users may need to seek professional assistance to understand the complex economic phenomena.
Both SFAC2 and SFAC8 include materiality as a qualitative characteristic. SFAC2 (1980:par124) includes materiality as a threshold for recognition of the other qualitative characteristics because it is a pervasive constraint as it relates to both relevance and reliability. However, SFAC8 (2010:QC11) includes materiality as an aspect of relevance.
Both SFAC2 and SFAC8 state that the benefits of financial reporting must exceed the cost of providing such information. SFAC8 (2010:QC35) also states that "cost is a pervasive constraint".
2.2 The arguments put forward by both the boards and commentators
Before the joint CF has been developed, there are arguments put forward by both the boards and commentators. According to FASB (2006:BC2.18), FASB and IASB concluded that the qualitative characteristic of faithful representation includes assuring that the substance of an economic phenomenon has represented by financial reports. Therefore, it would be redundant, if faithful representation includes the concept of substance over form.
The Audit Commission (2006), which is an independent body responsible for protecting the public purse and has responded to the IASB/FASB preliminary views on an Improved Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics of Decision-useful Financial Reporting Information. The Audit Commission (2006) has agreed with the other commentators' view, which is, by changing the term reliability into faithful representation, which is less well understood and may cause different interpretations, as a consequence, the inconsistency in financial reporting will become greater. Therefore, before the replacement of reliability with faithful representation, faithful representation must provide with a better definition (Audit Commission, 2006). Furthermore, the Audit Commission (2006) also have more concerns over substance over form does not include in the framework. The Audit Commission (2006) comments that if faithful representation includes the concept of substance over form, it would be more beneficial.
J. Edward Ketz (2008), who is an accounting professor, has agreed with the boards that if faithful representation includes the concept of substance over form, it would be redundant. Even though he has agreed with that, but he would still prefer to include substance over form as a component of representational faithfulness.
According to FASB (2010:QC13), a complete depiction of an economic phenomenon includes all information which is necessary for faithful representation. J. Edward Ketz (2008) has agreed with the boards, but he also mentioned the problem of oversimplifying accounting for complex accounting transactions may cause the accounting becomes incomplete and thus no longer faithful representation, so he suggested the boards to concern about the complexity.
FASB (2006:QC37) states that sometimes comparability has been confused with uniformity and an overemphasis on uniformity may reduce comparability. However, J. Edward Ketz (2008) claims that an underemphasis on uniformity may also produce a less comparable financial reports, such as lease accounting. So, the boards should prove for their claims about the overemphasis on uniformity.
According to FASB (2010:BC3.40), the users are assumed to have reasonable financial knowledge for financial information to be understandable. However, J. Edward Ketz (2008) suggested FASB to add in that "the ability to read a financial report does not imply a superficial understanding about the financial condition of the business enterprise" because the users may analyse a firm's condition wrongly as if he or she does not make enough analytical adjustments. So, to understand the financial reporting, the users have to be an expert in accounting and finance.
Both FASB and IASB have taken all the respond from the commentators into consideration and came out with the new joint CF. However, the conceptual framework still can be improved further.
SFAC2 has a hierarchy of accounting qualities to make decision with useful information. In the hierarchy, relevance and reliability are included as the primary decision-specific qualities, others as the components of these, and comparability including consistency as the secondary qualities. On the other hand, SFAC8 includes relevance and faithful representation as the fundamental qualitative characteristics, and comparability, verifiability, timeliness, and understandability as the enhancing qualities.
To conclude, the new hierarchy of accounting qualities in SFAC8 has significant improvement over the previous hierarchy of accounting qualities in SFAC2.