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Chapter 2: Question 25Q (page 61)

Statement of Financial Accounting Concepts No.5 identifies four characteristics that an item must have before it is recognized in the financial statements. What are these four characteristics?

Short Answer

Expert verified

Four characteristics that an item must possess in order to be recognized in the financial statements include:

  • Understandability
  • Relevance
  • Reliability
  • Comparability

Step by step solution

01

Meaning of Financial Statements

Financial statements are annual statements that disclose the financial performance and business activities of a firm. These statements are regarded as a means for decision-making by the management as well as outsiders like investors and shareholders, government authorities as well as creditors and financiers.

02

Four characteristics of financial statements

Four characteristics are essential for an item to be recognized in the financial statements. They are:

  • Understandability: The information must be presented in such a way that it is easily understandable by the users of the financial statements. The additional information should also be provided as a supporting footnote so as to help in clarification.
  • Relevance: The information provided must be suitable to the needs of the users so that it influences their decisions. This may include reporting appropriate information or information whose misstatement could affect the economic decisions of users.
  • Reliability: The information must be reliable in nature, which means it must be free from error and should not mislead the users.
  • Comparability: The information must be comparable in nature, which means it can be used to compare with the financial information presented in previous or future accounting periods, so as to enable the users in assessing the performance and financial position of the business.

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Most popular questions from this chapter

How is materiality (or immateriality) related to the proper presentation of financial statements? What factors and measures should be considered in assessing the materiality of a misstatement in the presentation of a financial statement?

Question: What are some of the differences in elements in the IASB and FASB conceptual frameworks?

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?

Question: (Qualitative Characteristics) Recently, your uncle, Carlos Beltran, who knows that you always have your eye out for a profitable investment, has discussed the possibility of your purchasing some corporate bonds. He suggests that you may wish to get in on the 鈥済round floor鈥� of this deal. The bonds being issued by Neville Corp. are 10-year debentures which promise a 40% rate of return. Neville manufactures novelty/party items.

You have told Uncle Carlos that, unless you can take a look at Neville鈥檚 financial statements, you would not feel comfortable about such an investment. Believing that this is the chance of a lifetime, Uncle Carlos has procured a copy of Neville鈥檚 most recent, unaudited financial statements which are a year old. These statements were prepared by Mrs. Andy Neville. You peruse these statements, and they are quite impressive. The balance sheet showed a debt-to-equity ratio of 0.10 and, for the year shown, the company reported net income of $2,424,240.

The financial statements are not shown in comparison with amounts from other years. In addition, no significant note disclosures about inventory valuation, depreciation methods, loan agreements, etc. are available.

Instructions

Write a letter to Uncle Carlos explaining why it would be unwise to base an investment decision on the financial statements that he has provided to you. Be sure to explain why these financial statements are neither relevant nor representationally faithful.

What is meant by term 鈥渜ualitative characteristics of accounting information鈥�?
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