Primary vs Secondary Characteristics

Primary Characteristics
Relevance – Information in financial statements is relevant when it influences the economic decisions of users. It can do that both by (a) helping them evaluate past, present, or future events relating to an enterprise and by (b) confirming or correcting past evaluations they have made.
Ingredients of relevance:
·         Predictive Value – Information can help users increase the likelihood of correctly predicting or forecasting the outcome of certain events.
·         Feedback Value – Information can help users confirm or correct earlier expectations.  Note that the predictive and confirmatory roles of information are interrelated.
·         Timeliness– Information loses its relevance if it is not timely
 Reliability – Information in financial statements is reliable if it is free from material error and bias and can be depended upon by users to represent events and transactions faithfully. Information is not reliable when it is purposely designed to influence users’ decisions in a particular direction.
Factors of reliability
·        Faithful Representation – Information must represent faithfully the transactions and events it either purports to represent or could reasonably purport to represent.
·     Substance over form – Transactions are to be accounted for and presented according to their substance and economic reality and not merely their legal form.
·      Neutrality – Information contained in the financial statements must be free from bias and error.
·     Prudence (Conservatism) – The inclusion of a degree of caution in the exercise of judgments needed in making estimates or choosing alternatives so that the outcome will have the least effect on equity.
·         Completeness – to be reliable, the information in the financial statements must be complete within the bounds of materiality and cost.
Constraints to Relevant and Reliable Information
·         Timeliness – Undue delay in reporting of information may lead to the loss of relevance even though enhancing it reliability.  While providing information before all aspects of a transaction or other events are known may increase the relevance of information, thus impairing its reliability.
·    Balance between Benefit and Cost – The benefits derived from relevant and reliable information should exceed the cost of providing it.
Secondary Characteristics
Understandability – Information should be presented in a way that is readily understandable by users who have a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently.
Comparability – Users must be able to compare the financial statements of an enterprise over time so that they can identify trends in its financial position and performance. Users must also be able to compare the financial statements of different enterprises. Disclosure of accounting policies is essential for comparability especially when the enterprise adopts a new or changes its accounting policies.

About Jonathan Ruiz CPA

Entrepreneur, CPA Mentor, Stock market Newbie Mentor, Influential Author and Master's Degree in International Business graduate in Hult International Business School, UK. A father of two lovely daughters.
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