The Financial Statement: understandability, relevance, reliability
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The financial statement should contain information "sufficient in quantity and quality to satisfy the reasonable expectations of the readers to whom it is addressed" (Statement of principles, 1999). According to the sentence, it is means that the financial statement should contain useful and meaningful information which included quantity and quality so that the reader who we make the financial statement to the person knows and understand it. How we achieve the quality information? Actually there are four characteristics of financial information. The four characteristics are understandability, relevance, reliability, and comparability.
First, understandability is including taking into consideration users' abilities, and aggregation and classification of information. Relevance is including having predictive value and confirmatory value. Next, Reliability is including faithful representation, being natural, free form material error, complete, and prudent. Comparability is including consistency and disclosure. All the characteristics are attributes that make the information provided in financial statements are useful to users.
Understandability includes users' abilities and aggregation and classification. According to the Framework, the information provided by financial statements needs to be readily understandable by users, it also means that users need to be able to perceive its significance. Besides that, those preparing financial statements are entitled to assume that users have a reasonable knowledge of business, economic activities and accounting and a willingness to study with reasonable diligence the information provided. To aid understandability, financial information is aggregated and classified according to standard disclosure formats which are the income statement and statement of financial position.
To provide a list of all the balances would be meaningless to users. For example, the benefit of providing a list of all the credit customer balances at the yearend limited, whereas a total figure for all the trade receivables does provide information that can be of use to users. They can compare the trade receivables in current year to those last year. This will give some indication as to how credit management has changed over time.
Relevance, from Framework information, the relevance is if the information has the ability to influence the economic decisions of users by helping them to evaluate past, present or future events or confirming, or correcting, their past evaluation. Therefore, information should have predictive value or confirmatory value. Information has predictive value if it helps users to evaluate or assess past, present or future events. To have prediction value, information need not be in the form of an explicit forecast. However, the ability to make predictions form financial statements is enhanced by the manner in which the information on the past is presented.
In additional, transaction newly acquired business, or business that are being disposed of, are reanalyzed and separately disclosed from transactions from continuing operations. Therefore, a diligent user can determine changes in the performance and financial position of the entity that resulted from normal activities that are expected to continue into the future. Information has confirmatory value if it helps users to confirm or correct their past evaluations and assessments. Relevant information can be more relevant when it is provided in a timely manner as it is more likely to influence decision-making.
Materiality which included in relevance, it is an underlying accounting concept. The relevance information is affected by its nature and materiality. Materiality provides guidance as to how a transaction or item of information should be classified in financial statement and/or whether it should be disclosed separately rather than being aggregated with other similar items. A common application of materiality concerns weather an item of expenditure is to be regarded as a non-current asset or an expense. Another common application of materiality relates to separate disclosure of certain items in financial managements. Users are unable to assimilate large amounts of detailed information. This necessitates considerable aggregation of data. Materiality provides guidance on what transactions are to be aggregated by virtue of its specifying which items should be disclosed separately.
Reliability is to be useful, information must also be reliable. The information has the quality of reliability when it is free material error; free from deliberate or systematic basic; can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. To be reliable, information should faithfully represent the underlying transaction or event, reflect the substance of the underlying transaction or event, be neutral, be prudent and complete. To be reliable, information provided in financial statements needs to be neutral. In other word, free from bias.
Prudence which included in the reliable is the historically one of the fundamental accounting concepts. The crux of prudence is prepares of accounting information should exercise prudent views when making judgments about uncertain items such as provisions for doubtful debts, asset lives or the number of warranty claims that might occur. It is also highlighted as one of the qualitative characteristics of accounting information. Prudence is deeply embedded in accounting and possibly even in the personality of many accountants. It is one of the main reasons why accountants are often described as conservative, prudent, cautious, and pessimistic and so on.
However, the important point is that these references to not overstating income or assets, and not understanding expenses or liabilities essentially refer to not overstating the profit in the income statement and financial position in the statement of financial position. Completeness, the financial statements must be complete within the bounds of materiality and cost. An omission can cause the financial statements to be false or misleading and thus unreliable and deficient in terms of its relevance.
Next, comparability is that users must be to compare the financial statement of an entity over time and relative to other entities in order to properly assess the entity's relative financial position, performance and changes in financial position. Therefore, financial statements should include the current year statements, the comprehensive income statement and statement of financial position, presented beside the prior year statements and it is also called as comparatives. To be able to view similarity prepared financial statements over time allows users to make judgments about trends in performance and in changes in financial position and use this information to predict into the future.
Consistency, it is in the application of accounting policies is vital for producing comparable information. Any changes to the accounting policies and the impact of these changes should be disclosed. Disclosure is included in the accounting policies. It is help to achieve comparability. To assist in the making of comparisons despite inconsistencies, users need to able to identify any differences between the accounting policies adopted by an entity to account for some transactions relative to others, accounting adopted from period by an entity and the accounting policies adopted by different entities. Some academics regard disclosure as a fundamental qualitative characteristic of financial statements.