Qualitative Characteristics of financial info

Question 1

How many qualitative characteristics are there in financial information?

Answer 1

The IASB Conceptual Framework has a series of concepts, or certain ‘qualitative characteristics’, which a business must embody in order for its financial statements to be useful to the stakeholders.

These are divided into fundamental qualitative concepts and enhancing qualitative concepts.

1. Fundamental qualitative characteristics:

• relevance
• faithful representation

2. Enhancing qualitative characteristics:

• comparability
• verifiability
• timeliness
• understandability

Question 2

Describe the fundamental qualitative characteristics in financial information?

Answer 2

Fundamental qualitative characteristics:

If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent.

The qualitative characteristics of ‘relevant’ and ‘faithfully representative’ are consistently conveyed in the Conceptual
Framework to make the financial information more useful to the entity’s various stakeholders.

Question 3

Describe the fundamental ‘relevance’ of qualitative characteristics in financial information?

Answer 3

Relevance

Financial information is regarded as relevant if it is capable of influencing the decisions of users.

In determining what is relevant to users, preparers of financial statements should consider whether information is
material and the extent to which reliable information may be omitted.

Information may be material or relevant simply because of its magnitude or because its omission from the financial statements could affect decision making.

Question 4

Describe the fundamental ‘faithful representation’ of qualitative characteristics in financial information?

Answer 4

Faithful representation

Faithful representation means that financial information must meet three criteria: completeness, neutrality and be free
from error.

• Completeness: all information that users need to understand the item is given.
• Neutral or unbiased: there is no bias in the selection or presentation of information.
• Free from error: there are no omissions, errors or inaccuracies in the process to produce the information.

This is something that cannot be completely eradicated, due to human error. Inaccuracies can arise, particularly in cases of
making estimates and judgements.

The financial reporting and accounting standards expect that the estimates are made on a realistic basis, not arbitrarily and the information contained within the financial statements presents a fair view of the organisation.

Question 5

What is the concept of prudence in financial reporting

Answer 5

1. Prudence is the exercise of caution when making judgements under conditions of uncertainty. It supports neutrality of information by ensuring that assets and income are not overstated and liabilities and expenses are not understated.
2. Measurement uncertainty is a factor that can affect faithful representation. For example, relevant information with
   a high level of measurement uncertainty may provide less useful information than less relevant information with a lower measurement uncertainty. It may be necessary to override the legal form of a transaction to portray the true economic position.

Question 6

What is the idea of substance over form’?

Answer 6

A lease agreement is a contract between two parties, the lessor and the lessee. The lessor is the legal owner of the asset, whereas the lessee obtains the right to use the asset in return for rental payments.

The idea of ‘substance over form’ is key for the faithful representation of financial information. For example, a lease might
not transfer ownership of the leased property to the lessee.

The lessee might nevertheless be required to record the leased item as an asset if the lessee receives most of the benefits of
ownership and also carries most of the risks, for example in relation to obsolescence of the asset.

Question 7

Describe the Enhancing qualitative characteristics in financial information?

Answer 7

Describe the Enhancing qualitative characteristics in financial information?

Information that is relevant and faithfully represented can be enhanced by the application of other characteristics. Such as:

1. Comparability
2. Verifiability
3. Timeliness
4. Understandability

Question 8

Describe each of the following:

1. Comparability

Answer 8

Comparability:

The accounting methods, including the presentation and classification of items in the financial statements, must be
applied consistently for similar situations.

This facilitates comparison with similar information about other entities and with similar information about the same entity for another period.

The consistency concept is important because of the need for comparability of financial statements.

Question 9

Describe each of the following:

2. Verifiability

Answer 9

Verifiability

Verifiability means that the accounting information presented in financial statements must be checked or demonstrated to be true, accurate or justified.

If information can be verified (such as by an independent accountant) this provides assurance to the users that it is both credible and reliable. If something is not verifiable, it is unlikely to be auditable; hence, its reliability and usefulness is diminished

Question 10

Describe each of the following:

3. Timeliness

Answer 10

Timeliness

Timeliness of accounting information is important due to its usefulness and relevance to the decision-making needs of
the users of financial statements.

Local legislation and market regulations impose specific deadlines on certain entities.

Timeliness is important to protect the users of the financial statements, such as potential investors, from outdated information or from delayed financial reporting

Question 11

Describe each of the following:

4. Understandability

Answer 11

Understandability

Information should be understandable through appropriate classification, characterisation and presentation of information.

Some financial transactions are inherently complex and difficult to understand, but to omit such information would not give a fair representation of the financial statements.

It is therefore important that the format and layout of the financial statements, the accounting policies applied, the terminology used and other statements made within the financial statements are clear and concise.

Question 12

What is the objective and scope of financial statements?

Answer 12

The objective of financial statements is to provide information about the assets, liabilities, equity, income and expenses of the reporting entity.

Financial statements are a particular form of financial report that provides useful information about the financial position, financial performance and cash flows of a reporting entity to a wide range of users.

This enables those users to make rational investment decisions such as buying, selling or holding equity and debt instruments and credit decisions such as providing or settling loans and other forms of credit.

Question 13

What is the meaning of financial statements?

Answer 13

Financial statements provide information about transactions and other events viewed from the perspective of the reporting entity as a whole.

Consolidated, unconsolidated and combined financial statements are all acknowledged as forms of financial statements in the revised Conceptual Framework.

Consolidated financial statements are generally considered to provide more useful information to users of financial statements than unconsolidated financial statements.

Question 14

What do we mean by ‘Going Concern’?

Answer 14

The Conceptual Framework requires financial statements and their underlying information to be prepared on a going-concern basis. The Conceptual Framework notes that financial statements are normally prepared assuming the entity is a going concern and will continue in operation for the foreseeable future.

Question 15

What are the elements of a financial statement?

Answer 15

What are the elements of a financial statement?

1. Assets
2. liabilities
3. equity
4. income
   5 expense

Question 16

Describe what we mean by asset?

Answer 16

Assets

An asset is a present economic resource controlled by the entity as a result of past events.

An economic resource is a right that has the potential to produce future economic benefits. For example, a property that is owned and controlled by an entity that is used to house operations and generate revenues would be classed as an asset.

Answer 17

Liabilities

A liability is a present obligation or duty of responsibility of the entity to transfer an economic resource as a result of past
transactions or events that the entity has no practical ability to avoid. For example, a trade payable is a liability.

Question 18

Describe what we mean by equity?

Answer 18

Equity

This is the ‘residual interest’ in the assets of the entity after deducting all its liabilities. It represents what is left when the
business is wound up, all the assets are sold and all the outstanding liabilities are paid.

It is effectively what is paid back to the owners (shareholders) when the business ceases to trade.

Question 19

Describe what we mean by income and expense?

Answer 19

Income

Income is increases in assets or decreases in liabilities that result in an increase in equity, other than those relating to contributions from holders of equity claims. Sales revenue is a good example of income.

Expenses

Expenses are decreases in assets or increases in liabilities that result in a decrease in equity, other than those relating to distributions to holders of equity claims. The cost of goods or services is an example of an expense.

Question 20

What do we mean by ‘Substance over form’?

Answer 20

Substance over form implies that the transactions recorded in the financial statements must reflect their economic
substance rather than their legal form alone.

For example, patents and intellectual property are assets controlled by the entity and have future economic benefits although they do not have any physical form.

Transactions or events that are expected to occur in the future do not, in themselves, give rise to assets. For example, merely an intention to purchase a building does not, in itself, meet the definition of an asset.