Qualitative Characteristics of Useful Information Flashcards
Identify the qualitative characteristics of accounting information.
1
Q
What does choosing an acceptable accounting method, the amount and types of information to be disclosed, and the format in which information should be presented involve determining?
A
Which alternative gives the most useful information for decision-making purposes (decision usefulness)
2
Q
What is decision usefulness?
A
Approach to financial reporting whereby the amount and types of information to be disclosed and the format in which information should be presented are determined based on which alternative provides the most useful information for decision-making purposes.
3
Q
The conceptual framework’s second level has identified the qualitative characteristics of accounting information that distinguish what infromation?
A
Information that is better (more useful) for making decisions from information that is inferior (less useful).
4
Q
What is relevance?
A
A qualitative characteristic of accounting information that indicates that it must make a difference in a decision.
5
Q
What is representational faithfulness (faithful representation)?
A
A qualitative characteristic of accounting information that represents economic reality. It is transparent, complete, neutral, and free from material error and bias.
6
Q
What are relevance and representational faithfulness?
A
Fundamental qualities that make accounting information useful for decision-making. Above all else, these two characteristics must be present.
7
Q
What must accounting information be to be relevant?
A
Be capable of making a difference in a decision. Piece of information has no impact on a decision=irrelevant to decision. Care should be taken to ensure that relevant information is included in financial reporting.
8
Q
What is it called when relevant information helps users make predictions about the final outcome of past, present, and future events?
A
It has predictive value.
9
Q
What is predictive value?
A
A characteristic of accounting information that helps users make predictions about the ultimate outcome of past, present, and future events.
10
Q
Give an example of relevant accounting information having predictive value.
A
Separating income from continuing operations from that of operations that have been discontinued may help users predict future income
11
Q
What is it called when relevant information helps users make predictions of final outcomes of events?
A
It has predictive value
12
Q
What is called when relevant information help users confirm or correct their previous expectations?
A
Feedback/confirmatory value
13
Q
What is feedback/confirmatory value?
A
The notion that relevant information helps users confirm or correct prior expectations.
14
Q
Give an example of relevant information having feedback/confirmatory value?
A
Providing information about rental income and the value of the investment in rental properties might help users assess how well management is managing the investment in rental properties.
15
Q
What is materiality?
A
The concept relates to an item’s impact on a company’s overall financial operations. An item is material if its inclusion or omission would influence or change the judgement of a reasonable person.
How important a piece of information is
16
Q
Information is thought to be material if it….?
A
Would make a difference to the decision-maker
17
Q
Give an example of material information.
A
A major product defect would be of interest to a potential investor
18
Q
Material information is relevant therefore what should it be included in?
A
In the financial statements
19
Q
When determining whether something is material or not, what is the amount in question often compared with?
A
The entity’s amounts of other revenues and expenses, assets and liabilities, or net income.
20
Q
Why is it hard to give firm guidelines to decide when an item is or is not material?
A
Depends on both a relative amount and relative importance
21
Q
What does 4.3.4 current auditing standards (CAS 320.A7) define?
A
What is material by using benchmark examples from different types of organizations.
22
Q
What does the 4.3.4 current auditing standards (CAS 320.A7) consider?
A
Considers 5% of pre-tax income from continuing operations for manufacturing companies and 1% of revenues for not-for-profit entities to be material. This is not a definitive rule and is a fairly simplistic view of materiality.
23
Q
In addition to the 4.3.4 current auditing standards (CAS 320.A7), what else should be considered when deciding if information is material?
A
Item’s impact on other factors, ex: key financial statement ratios and management compensation (on any sensitive number on the financial statements). In addition, both quantitative and qualitative factors must be considered
24
Q
What are examples of qualitative factors that may be considered in deciding if an item is material?
A
- Illegal acts
- Failure to comply with regulations
- Inadequate or inappropriate description of an accounting policy
25
Is materiality only used in external decision?
No, its also a factor in a large number of internal accounting decisions
26
Judgements should be determined based on reasonableness and practicality with what 3 things?
- The amount of classification required in a subsidiary expense ledger
- The degree of accuracy required in prorating expenses among the departments of a business
- The extent to which adjustments should be made for accrued and deferred items
| Not too important, just examples
27
Why must we sensibly apply the materiality constraint?
Only by exercising good judgement and professional expertise can we find reasonable and appropriate answers
28
What is the overall objective of an audit?
To determine whether the financial statements are materially misstated or not. The auditor must complete audit procedures to gain this assurance
29
What is the first step of an auditor using the concept of materiality?
In the planning stages: to help decide how many and what type of audit procedures to perform on particular transactions or balances. More work would be done on balances and transactions that are thought to be material.
30
What is the second step of an auditor using the concept of materiality?
During the audit: to refine the amount and type of audit procedures being done, given the findings.
Ex: in the planning stages, the auditor might not think something is material but when the audit is being performed, some new information might come to light.
31
What is the third and final step of an auditor using the concept of materiality?
In assessing whether the financial statements are materially misstated and whether they can give an unmodified audit opinion, which states that the financial statements are fairly presented. The auditor will generally find things that need adjusting in the financial statements and must decide whether these adjustments have to be made or not. As long as the financial statements are not materially misstated, an unmodified opinion may be given.
32
Give an example of how PwC (an auditor) gave Air Canada an unmodified audit opinion.
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Air Canada and its subsidiaries as at December 31, 2017 and December 31, 2016 and their financial performance and their cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board.
Montreal, Quebec
February 15, 2018
33
To what extent is accounting information representationally faithful?
To the extent that it faithfully reflects or represents the underlying economic substance of an event or transaction, not just its legal form
34
What is economic substance?
The underlying economic reality reported on a representationally faithful document.
35
Why do companies sometimes structure transactions a certain way from a legal perspective?
In order to manage risk, protect the company from lawsuits, or minimize income taxes. Thus, the legal form of the transaction may be quite complex and may differ from the economic substance or intent
36
What does the conceptual framework require when companies structure transactions through a legal perspective and it becomes complex/differs from economic substance? What is this notion called?
That the financial statements reflect the economics of the transaction notwithstanding the legal structure. Called: economic substance over legal form
37
What is the notion of representing economic reality sometimes called?
Transparency
38
What is transparency?
A goal of financial reporting such that the information provided reflects the underlying transactions and events and their effects on a company. It is one of the characteristics of representational faithfulness.
39
Why is it critical that financial statement users are able to read the financial statements and see what lies beneath the numbers?
The statements are meant to tell a story about the business:
- Is this a risky business?
- Is it a mature business?
- Is it capital-intensive?
40
What 3 criteria does information that is representationally faithful meet?
- Complete
- Neutral
- Free from error
41
How do highly uncertain estimates affect representational faithfulness?
Ex: where the only information about an amount (such as the estimated potential loss on a lawsuit) is highly uncertain, perhaps additional disclosure may be necessary to explain this
42
What is completeness?
The quality of accounting information that makes it reliable by including all information necessary to provide an accurate portrayal of events and transactions.
43
Why must care be taken to ensure pertinent information is included?
Since it is possible to misrepresent something by not including all pertinent information. Often this is a question of the amount of details to be presented
44
Give an example of why its important tp ensure pertinent information is included.
it is important to note the nature of capital assets that an entity has under its control, including property, plant, and equipment. But presenting the amortized cost of such investments might not be sufficient if some of these assets are leased.
45
What is the presumption about most property, plant, and equipment that is reported on a statement of financial position?
The company has legal title to the property. Therefore, if this is not the case—in other words, the assets are leased—this additional information should be presented.
46
What is neutrality?
The quality of accounting information that ensures faithful representation by being factual, truthful, and unbiased. Shouldn't be selected to favour one set of interested parties over another. It shouldn't be manipulated in any way
47
What needs to be the overriding consideration when preparing financial information?
Factual, truthful, unbiased information
48
What is conservatism?
The exercise of caution where making decisions under conditions that are uncertain. Also known as prudence.
49
In situations involving uncertainty and professional judgement, historically, what has the concept of conservatism meant?
Net assets and net income would not be overstated
50
What does conservatism acknowledge?
A pre-existing tendency of companies to overstate net assets and net income and it acts to counterbalance this tendency
51
Users of financial statements are more tolerant of _______ net assets and net income than ______ balances.
Understated, overstated
52
Does the use of conservatism represent a bias?
Many believe that it does. The concept of conservatism was originally downplayed in the 2015 IASB Exposure Draft relating to the conceptual framework in favour of neutrality.
53
Although the concept of conservatism was downplayed in the 2015 IASB Exposure Draft relating to the conceptual framework in favour of neutrality, what standards have conservatism embedded in them?
There are many existing standards, both in IFRS and ASPE, where conservatism is embedded.
54
Give an example of conservatism embedded in existing standards (IFRS and ASPE).
For instance, where cost is used as a measurement basis (as opposed to fair value), accountants feel quite justified and even compelled to override the historical cost principle and write down the carrying value of an impaired asset
55
How did the IASB decide to reintroduce the concept of conservatism and what did they call it?
After much consultation it was reintroduced in the new IASB conceptual framework, noting that caution should be exercised when uncertainty exists. They called it prudence
56
What is prudence?
The exercise of caution in making decisions where uncertainty exists. See also Conservatism.
57
What are the changes the IASB made to conservatism when reintroducing it as prudence?
The concept is more even-handed, however, since in defining the word “prudence,” the conceptual framework notes that care should be taken to ensure, ex: that assets and income are not overstated but not understated either
58
How does AcSB's version of conservatism differ from others?
Included in their conceptual framework, noting that conservatism affects the concept of neutrality in an acceptable way. Thus the notions of conservatism and neutrality aren't necessarily in conflict with each other
59
Neutrality is supported by what concept?
Concept of conservatism/prudence
60
In practice, why does management need to use many assumptions?
Because of uncertainty in financial reporting, such as uncertainty caused by accrual accounting.
61
Give an example of management needing to use assumptions because of uncertainty in financial reporting.
Revenues are recorded when earned and not necessarily when cash is received, thus companies must estimate the amount of revenue that will be realized or eventually collected
62
What must management use when choosing assumptions, and why?
Must use its best estimates (management best estimate) in order to portray the economic reality
63
What is management best estimate?
Assumptions made by management in light of their knowledge and familiarity with the company, the industry, and the economy.
64
What 2 qualities are management's best assumptions supposed to have?
1. Unbiased
2. Involve management making diligent efforts to obtain and use all information that it has access to to come up with the best-quality information
65
Producing financial statements with biased information can have significant negative consequences, not only for investors and creditors, but also for _________
Financial statement preparers and company management
66
What is another aspect to neutrality?
Neutrality in standard setting
67
What is the economic consequences argument?
Some observers argue that standards should not be issued if they cause undesirable economic effects on an industry or company
68
Although the economic consequences argument exists, why must standards be free from bias?
Or we will no longer have credible financial statements
69
Standard setters should choose the best standards regardless of what?
Economic consequences
70
If the accounting results in users changing their decisions, then by definition, the information is_______
Decision relevant
71
What is freedom from error?
A measure of the reliability of reported information, assuring that the relevant information is accurate and unaffected by the opinions of stakeholders.
## Footnote
Aka: information must be reliable
72
Why must management make estimates and use judgment in determining how to portray events and transactions?
The task of converting economic events (which are constantly changing and difficult to measure) to numbers in a set of financial statements is complex
73
What does not being "perfectly accurate in all respects" mean?
Often, there is no correct or single right way to portray economic reality.
74
Give a example of not being "perfectly accurate in all respects".
How does a company portray the impact of a major ecological disaster such as an oil spill? Significant assumptions must be made about cleanup activities in order to estimate potential costs and liabilities
75
Why should every attempt be made to be free from material error?
Because information is more useful if it is free from material error
76
Why must companies ensure that they invest in good information systems?
So that they can capture necessary information and must also have strong internal controls to ensure that errors and omissions are minimized
77
In order to ensure that both fundamental characteristics of useful information (relevance and representational faithfulness) are present, what 3 steps should be taken?
1. Identify the economic event or transaction.
2. Identify the type of information about that transaction or event that would be relevant and can be faithfully represented.
3. Assess whether the information is available and can be faithfully represented.
78
What is considered an economic event in step 1: "identify the economic event or transaction"
For instance, assume that an investment in shares of a publicly traded company has increased in value. This is an economic event.
79
Give an example of the type of information that would be relevant in step 2: "Identify the type of information about that transaction or event that would be relevant and can be faithfully represented."
Might be the fair value of the investment.
80
Give an example of step 3: "Assess whether the information is available and can be faithfully represented."
Since the shares are publicly traded, fair value is available and could easily be presented faithfully in the financial statements
81
What are the 4 enhancing qualitative characteristics?
1. Comparability
2. Verifiability
3. Timeliness
4. Understandability
82
What is information that has been measured and reported in a similar way (both company to company and consistently from year to year) considered as?
Comparable
83
What is comparability?
What occurs when information that has been measured and reported in a similar manner for different companies is considered comparable
84
What does comparability enable users to do and how?
identify the real similarities and differences in economic phenomena because these have not been obscured by accounting methods that cannot be compared
85
How is the accounting for inventory different under IFRS and U.S. GAAP?
U.S. GAAP allows the use of last-in, first-out (LIFO) accounting, for instance, whereas IFRS does not
86
How is the result of the accounting for inventory being different under IFRS and U.S. GAAP a (non) example of comparability?
In times of rising prices, companies using LIFO, such as Walmart Inc., will have lower net incomes than companies not using LIFO, such as Loblaw Companies Limited.
87
What do resource allocation decisions involve, and when is it easier to make a valid evaluation?
Evaluations of alternatives, and easier if comparable information is available
88
Although a full disclosure of information is not a substitute for comparable information, what can it allow users to do?
Sometimes allows users to overcome inconsistencies in how information is presented
89
What is verifiability?
The quality of information that demonstrates that independent measurers, using the same measurement methods, obtain similar results.
90
When does verifiability exist?
When knowledgeable, independent users achieve similar results or reach consensus regarding the accounting for a particular transaction
91
Give an example of numbers that are more easily verified than others.
Cash can be verified by confirming with the bank where the deposit is held
92
Give an example of numbers that are harder to verify than others.
Accruals for pension liabilities are more difficult (although not necessarily impossible) to verify, as many assumptions are made to arrive at an estimate
93
What are "hard" numbers?
Numbers that are easy to verify with a reasonable degree of accuracy
94
What are "soft" numbers?
Those that are more difficult to measure
95
What is timeliness?
A characteristic of relevance that states that information should be available for decision-makers before it loses its capacity to influence their decisions.
96
How does quarterly reporting help with timeliness?
Provides info on a more timely basis. Thus, users have information throughout the year instead of waiting until after the year's end for the annual financial statements
97
Users need to have ___________ of business and financial accounting matters in order to understand the information in financial statements
reasonable knowledge
98
Although a user may be reasonably informed, what else must the financial information be for the user to see its significance?
Be of sufficient quality and clarity
99
What is understandability?
The quality of information that permits reasonably informed users to perceive its significance.
100
Standard setters assume that users have what responsibility when viewing information?
The responsibility to review and analyze the information with reasonable diligence
101
Who does the onus to prepare understandable statements and to be able to understand them rest with, and what does it affect?
With both the financial statement preparer and the user. This affects both how information is reported and how much is reported.
102
What is the assumption of the user when the underlying transactions or economic events are more complex?
That users will seek the aid of an advisor
103
What is the assumption of the preparer when the underlying transactions or economic events are more complex, and why?
Must also have a clear understanding of the legalities and economics of transactions in order to be able to portray them in the most meaningful way to users
104
What project on frameworks for disclosures is the IASB currently working on?
In order to ensure that information presented is decision-useful including being understandable
105
In general, preparers of financial information should identify all _____ information, then consider how best to ensure that the financial statements are presented such that they reflect the_________
Relevant, representational faithfulness
106
What 2 characteristics must be present in order to ensure the information is decision-relevant?
1. Relevant
2. Representational Faithfulness
107
What happens when its not possible for financial information to have all the enhancing qualities of useful information?
Trade-offs may exist
108
What is an example of a tradeoff?
To provide more relevant info, a new standard may be applied prospectively. In this case, comparability (or consistency year to year) is temporarily sacrificed for better information in the future
109
The accounting profession is constantly striving to produce financial information that meets all of what characteristics?
Qualitative characteristics of useful information
110
Why must the cost-benefit relationship be considered?
Too often, users assume that information is a cost-free commodity. But preparers and providers of accounting information know this is not true
111
What is the cost-benefit relationship?
A constraint of financial reporting that the costs of obtaining and providing information should not be higher than the benefits that are gained by providing it.
112
What happens when cost-benefit relationship is considered?
The costs of providing the information must be weighed against the benefits that can be had from using the information
113
In order to justify requiring a particular measurement or disclosure, what must the costs be justified by?
The benefits
## Footnote
In other words, the benefits must outweigh the costs.
114
What is the difficulty in cost-benefit analysis?
That the costs and, especially, the benefits are not always evident or measurable
115
There are several kinds of costs, name 6.
1. Collecting and processing
2. Distributing
3. Auditing
4. Potential litigation
5. Disclosure of proprietary information to competitors
6. Analysis and interpretation
116
The benefits in a cost-benefit relationship are enjoyed by what 2 groups?
Both the preparer and users
117
What benefits does the preparer experience in a cost-benefit relationship?
In terms of greater management control and access to capital
118
What benefits does the user experience in a cost-benefit relationship?
In terms of allocation of resources, tax assessment, and rate regulation
119
What is generally more difficult to quantify than costs?
Benefits
120
How has the AcSB taken some steps to reduce the cost of providing information?
By developing separate standards for private entities that are less onerous and costly. lt allows these companies to follow a simplified version of GAAP based on cost-benefit considerations
121
What benefits do the shareholders and creditors of private companies get from the AcSB's separate standards for private companies?
Have greater access to information and do not necessarily rely solely on the external financial statements
122
What benefits do smaller private companies get from the AcSB's separate standards for private companies?
The business and business model are not as complicated and therefore less complex accounting standards are required.
## Footnote
Private entities have the option to use IFRS if they wish.
