CIMA BA3 Syllabus A. ACCOUNTING PRINCIPLES, CONCEPTS AND REGULATIONS - Qualitative characteristics - Notes ^{11 / 22}

The IASB’s Conceptual Framework for Financial Reporting

The IASB’s Conceptual Framework for Financial Reporting describes the basic concepts by which financial statements are prepared. 

The main purpose of the Framework is to:

1. assist in the development of future IFRS and the review of existing standards by  setting out the underlying concepts

2. promote harmonisation of accounting regulation and standards by reducing the number of permitted alternative accounting treatments

3. assist the preparers of financial statements in the application of IFRS, which would include dealing with accounting transactions for which there is not (yet) an accounting standard.

Qualitative Characteristics of Financial Information

For decisions to be made, the information must be relevant to the decision and be clearly presented, stating any assumptions upon which the information is based, so that the user may exercise judgement as appropriate.

The revised Framework distinguishes between two types of qualitative characteristics that are necessary to provide useful financial information:

• Fundamental qualitative characteristics
   
  - relevance and 
  - faithful representation)

• enhancing qualitative characteristics 

  - comparability (including consistency), 
  - timeliness, 
  - verifiability and 
  - understandability).

Fundamental Qualitative Characteristics

For information to be useful, it must be both relevant and faithfully represented

1. Relevance

   • Influences economic decisions of user

     Relevant financial information is capable of making a difference in the decisions made by users

   • Has predictive value and/or confirmatory value or both

     Relevant information assists in the predictive ability of financial statements. 

     That is not to say the financial statements should be predictive in the sense of forecasts, but that (past) information should be presented in a manner that assists users to assess an entity’s ability to take advantage of opportunities and react to adverse situations.

   • Materiality

     Materiality is a threshold or cut-off point for information whose omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.  

     This depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.  

     Hence, materiality is not a matter to be considered by standard-setters but by preparers and their auditors.

2. Faithful Representation

   General purpose financial reports represent economic phenomena in words and numbers. 

   To be useful, financial information must not only be relevant, it must also represent faithfully the phenomena it purports to represent. 

   Financial statements will generally show a fair presentation when

   • They conform with accounting standards
   • They conform with the any relevant legal requirements
   • They have applied the qualitative characteristics from the Framework.

   Financial information that faithfully represents economic phenomena has three characteristics: -

    it is complete
    it is neutral
    it is free from error

Enhancing Qualitative Characteristics

Comparability, verifiability, timeliness and understandability are directed to enhance both relevant and faithfully represented financial information. 

Those characteristics should be maximised both individually and in combination.

1. Comparability

   • Users can identify similarities and differences

     Comparability is fundamental to assessing the performance of an entity by using its financial statements. 

     Assessing the performance of an entity over time (trend analysis) requires that the financial statements used have been prepared on a comparable (consistent) basis.

   • Consistent application of methods

     Comparability is enhanced by the use and disclosure of consistent accounting policies. 

     Users can confirm that comparative information for calculating trends is comparable. 

     The disclosure of accounting policies at least informs users if different entities use different policies.

     Comparability should be distinguished from consistency (the consistent use of accounting methods).  

     It is recognised that there are situations where it is necessary to adopt new accounting policies (usually through new Standards) if they enhance relevance and reliability. Consistency and comparability require the existence and disclosure of accounting policies.

2. Verifiability

   Financial information is verifiable when it enables knowledgeable and independent observers to reach a consensus on whether a particular depiction of an event or transaction is a faithful representation.

3. Timeliness

   Timeliness means that information is available to decision-makers in time to be capable of influencing their decisions.

4. Understandability

   Understandability is enhanced when the information is:

   • classified

   • characterised

   • presented clearly and concisely

However, relevant information should not be excluded solely because it may be too complex and cannot be made easy to understand.

To exclude such information would make financial reports incomplete and potentially misleading.

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information with diligence.

The Cost Constraint on Useful Financial Reporting

Cost is a pervasive constraint to financial reporting. Reporting such information imposes costs and those costs should be justified by the benefits of reporting that information. 

The IASB assesses costs and benefits in relation to financial reporting generally, and not solely in relation to individual reporting entities. 

The IASB will consider whether different sizes of entities and other factors justify different reporting requirements in certain situations.