Qualitative characteristics are the attributes that make financial information useful to users. The qualitative characteristics of financial information can be categorized as fundamental (relevance and faithful representation) or enhancing (comparability, verifiability, timeliness and understandability) based on how they influence the usefulness of financial information.
Fundamental Qualitative Characteristics of Financial Information
Relevant financial reporting information means the ability of users (shareholder) to make a difference in their decision. Information regarding to economic phenomenon will help the users make a difference decision if it included predictive value and confirmatory value.
- Predictive Value: Information has predictive value if the value can be useful to the shareholder in predicting certain things that is related to future. Information which is highly predictable does not necessary has predictive value. For instance, depreciation of plant and equipment by using straight line method can be highly predictable every year, but it cannot assist in evaluating the net cash flows.
- Confirmatory value: Information has confirmatory value if it confirms the validity of prior expectation or correcting them according to the prior evaluations. The outcomes will be same as past expected if the information has confirmed past expectation while the outcome can be changed if correcting in past expectations occurred.
2. Faithful Representation
Useful financial information needs not only be a relevant but also be a faithful representation. Financial reporting information included the characteristics of complete, neutral, and free from material error is supposed to be faithful representation of an economic phenomenon. A single description in financial reports may correspond to multiple economic phenomena. For instance, the plant and equipment presents in the balance sheet may stand for all the plant and equipment that owned by entity.
- Complete: Complete financial reporting information must have all the necessary information which is useful for decision making and should not be missing a material fact or consideration that would cause the financial reporting information misleading.
- Neutrality: Neutrality in financial reporting information must be free from bias which the information provided does not favor to the particular group over other interested person. In order to have neutral information, information must report in faithful and trustworthiness condition without changing anything that need to be conveyed for the purpose of inducing someone’s behavior.
- Free from error: A set of financial reporting information is said to be true if the information is free from error. However, due to some constraint and uncertainty in economy phenomena, financial reporting information does not provide absolutely value which is totally free from error. Therefore, a various type of judgments and estimation based on appropriate input are used by the management in assessing the financial reporting.
Relevance is the fundamental qualitative characteristics of financial information which connected to the economic phenomena and must be considered first before the other qualitative characteristics. Once the relevance is applied to distinguish which economic phenomena should be presented, faithful representation is going to determine which characteristics are best to correspond to the relevant phenomena. Therefore, relevance and faithful representation must work in a line to provide useful financial information to the users.
Enhancing Qualitative Characteristics of Financial Information
Enhancing qualitative characteristics of financial information are additional benefit added to the fundamental to enhance the decision usefulness of financial information.
- Comparability: Comparability refers to the ability of the users to distinguish similarities and differences between two economic phenomena. Comparability between entities and consistency in the application of methods or procedures over time period will enhance the informational value in relative economic performance. In order to maximize the fundamental qualitative characteristics, some degree of comparability should be included in relevant and faithful representation.
- Verifiability: Verifiability refers to the capable of the users to ensure that the information faithfully represents what it purports to represent and to ensure the selected technique of measurement had been used is without bias and error. The information is verified when the different evaluators or observers who are knowledgeable confirmed and come up with the same result. Verification can be distinguished as direct or indirect. Direct verification can be verified through an amount or other representation while indirect verification refer to the amount or other representation which is verified by examining the inputs and recount the outputs by adopting same accounting convention.
- Timeliness: Timeliness means that the information must be received by the users at the right time before it loses its ability to affect the decision. Information should be provided with sufficient timeliness to give a clear and meaningful picture for the shareholders. Information that is not available when it is needed by the decision makers will be useless and the information may lose its potential value.
- Understandability: Understandability means that the quality of financial information that the users could be able to identify or discover the meaning of the message that trying to be shown. Users of financial statements are assumed to have sufficient knowledge to study the information properly. If the information is classified, clearly represent and concise, it will help to enhance understandability. Sometimes, the information is complicated and hard to understand, the users may seek an advisor to explain to them.
Enhancing qualitative characteristics of financial information provide additional benefit and usefulness in the financial reporting information. Therefore, the four important characteristics which are comparability, verifiability, timeliness and understandability should be extent widely. However, the enhancing qualitative characteristics will be useless if the financial information is irrelevant or not faithfully represented in fundamental step. The application of the enhancing qualitative characteristics is redundant process that does not follow priority and prescribed order. Sometimes, one or some of the enhancing qualitative characteristics will be given up to maximize the usefulness of another qualitative characteristic. If such situation happened, appropriate information or evidence should be disclosed.