Introduction
The accounting function is essential in every business, but not simply for keeping track of income, expenses and tax payments as many may think. In fact, the primary attribute of accounting information is to provide accurate and relevant financial data to decision makers so that they can act reasonably. Both fundamental and enhancing qualities are important to consider when creating or evaluating a company's financial statements.
Fundamental Qualities of Accounting Information
The fundamental qualities of accounting information are relevance and reliability, also known as representational faithfulness. If accounting data is to be relevant and useful to decision makers if must be timely. Information gathered from the company's past can be used to make predictions about what might happen in the future, but the most recent data must be included and considered as well. If the statements being reviewed are from six months ago, they don't reflect the company's current financial standing and it will be difficult for managers or owners to make wise decisions. Therefore it is especially important for small business owners to remain current and stay on top of recording their day to day transactions so they can accurately assess how well they are doing financially.
Accounting information should satisfy the following criteria:
Understandability
This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities
Relevance
This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?)
Consistency
This implies consistent treatment of similar items and application of accounting policies
Comparability
This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability.
Reliability
This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor).
Objectivity
This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest
Enhancing Qualities of Accounting
Other qualitative characteristics of accounting information are referred to as secondary or enhancing qualities. These include consistency, understandability and comparability. Accountants use standardized practices so that information is recorded, calculated and analyzed in ways that are the same from period to period. For example, if expenses were recorded in one period based on a certain set of criteria and then recorded based on a different set of rules or thresholds within the next period, the data would reflect the outcome of the company's finances very differently between the two periods. Consistent accounting practices avoids these types of discrepancies.
Clear and Understandable Statements
A third enhancing quality of accounting is understandability. Simply put, someone with a reasonable amount of accounting or business knowledge should be able to read and understand your company's financial reports. Statements that include lengthy explanations or data that confuses the bottom line may be evidence of a company's attempt to gloss over poor performance.
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