Question

Accounting information provides useful information about business transactions and events. Those who provide and use financial reports must often select and evaluate accounting alternatives. The FASB statement on qualitative characteristics of accounting information examines the characteristics of accounting information that make it useful for decision-making. It also points out that various limitations inherent in the measurement and reporting process may necessitate trade-offs or sacrifices among the characteristics of useful information.

Instructions

a) Describe briefly the following characteristics of useful accounting information.

1. Relevance (4) Comparability

2. Faithful representation (5) Consistency

3. Understandability

b)For each of the following pairs of information characteristics, give an example of a situation in which one of the characteristics may be sacrificed in return for a gain in the other.

1. Relevance and faithful representation.

2. Relevance and consistency.

3. Comparability and consistency.

4. Relevance and understandability.

c) What criterion should be used to evaluate trade-offs between information characteristics?

Short answer

(a)

(1) Relevant information helps users predict the results of past, present, and future events or affirm or rectify previous expectations.

(2) Faithful representation is an agreement made between financial information and economic event and is considered to show emerging from completeness, objectivity and free from error.

(3) Understandability is an association between users who differ widely in their extent to understand or utilize the information and decision-specific qualities of information.

(4) Comparability improves comparisons among the information about the two different firms at a specific point in time.

(5) Consistency improves comparisons among the information about the same firms at two different points in time.

(b)

(1) Predictions of future operating outcomes and projections of future cash flows may be greatly related to a few decision-makers.

(2)Proposal of new accounting methods may be more suitable for many decision- makers than the current ones.

(3) There is quite a variation among acceptable accounting procedures and methods to aid comparability between firms.

(4) Sometimes, appropriate information is exceptionally complex. Judgement is needed in ascertaining the optimum trade-off between relevance and understandability.

(c)

Even though the trade-offs lead to the loss of some desirable quality of information, the overall outcome should be information that is more beneficial for decision making.

Step-by-step solution

Meaning of Accounting Information 

Accounting information is defined as the accounting statements produced by the process of book-keeping and accounting, that is, trading account, profit and loss account and balance sheet.

Explanation for statement ‘a’ 

1. Relevance is one of the two basic decision-specific features of beneficial accounting information. Relevant information is proficient in creating a difference in a decision. Relevant information helps users predict the results of all events, whether past, present or future or affirm or rectify previous expectations.

2. Faithful representation is another basic decision-specific feature of beneficial accounting information. Reliable information can be based upon to show the conditions and events that it is considered to define. Representational faithfulness is an agreement made between accounting information and the economic event it is considered to show occurring fromneutrality, wholesomeness and error-free.

3. Understandability is a user-specific feature of information. Information is understandable when it allows one to consider its importance. Understandability is an association between users who differ entirely in their capability to understand and the decision-specific nature of the information.

4. Comparability implies that information about firms has been made and shown in the same way. Comparability improves comparisons between information about various firms at a specific point in time.

5. Consistency implies that the firm has implemented unvarying procedures and policies from one cycle to the other. Consistency improves comparisons between information about a similar firm at two distinct points in time.

Explanation for statement ‘b’ 

1. Predictions of future operating outcomes and projections of future cash flows may be greatly considered by some decision creators. However, they would not be error-free as compared to historical cost information about prior transactions.
2. Many decision-makers may consider new accounting methods more than current methods. However, if prevalent, they would undermine consistency and make comparisons of a firm’s outcomes over difficult times.
3. There is much variation among acceptable accounting procedures and methods. To ease comparability among firms, implementing only one accepted accounting method for a specific transaction is needed. However, it can hinder the consistency of those firms varying to the new methods.
4. Sometimes, considered information is far more complex. Judgement is needed in ascertaining the optimum trade-off between understandability and relevance. Information about the impact of general and specific price alterations may be greatly considered but not comprehendible by all users.

Explanation for statement ‘c’ 

Accounting information gives beneficial information about the transactions as well as events of the business. Those who supply and use financial reports must usually select and estimate accounting substitutes. Even though the trade-offs lead to the loss of some desirable information quality, the whole outcome should be information that is more beneficial for making a decision. It also highlights different disadvantages present in the measurement and listing process that may require trade-offs or sacrifices among the features of beneficial information.