This page contains a a summary of Financial Accounting Concept No. 2. Use this information to explain the information found on this diagram.

Statement of Financial Accounting Concepts No. 2
Qualitative Characteristics of Accounting Information

Summary Of Principal Conclusions

The purpose of this Statement is to examine the characteristics that make accounting information useful.  Those who prepare, audit, and use financial reports, as well as the Financial Accounting Standards Board, must often select or evaluate accounting alternatives.  The characteristics or qualities of information discussed in this Statement are the ingredients that make information useful and are the qualities to be sought when accounting choices are made.

All financial reporting is concerned in varying degrees with decision making (though decision makers also use information obtained from other sources).  The need for information on which to base investment, credit, and similar decisions underlies the objectives of financial reporting.  The usefulness of information must be evaluated in relation to the purposes to be served, and the objectives of financial reporting are focused on the use of accounting information in decision making.

The central role assigned to decision making leads straight to the overriding criterion by which all accounting choices must be judged.  The better choice is the one that, subject to considerations of cost, produces from among the available alternatives information that is most useful for decision making.

Even objectives that are oriented more towards stewardship are concerned with decisions.  Stewardship deals with the efficiency, effectiveness, and integrity of the steward.  To say that stewardship reporting is an aspect of accounting's decision making role is simply to say that its purpose is to guide actions that may need to be taken in relation to the steward or in relation to the activity that is being monitored.

 A Hierarchy of Accounting Qualities

The characteristics of information that make it a desirable commodity can be viewed as a hierarchy of qualities, with usefulness for decision making of most importance.  Without usefulness, there would be no benefits from information to set against its costs.

User-Specific Factors

In the last analysis, each decision maker judges what accounting information is useful, and that judgment is influenced by factors such as the decisions to be made, the methods of decision making to be used, the information already possessed or obtainable from other sources, and the decision maker's capacity (alone or with professional help) to process the information.  The optimal information for one user will not be optimal for another.  Consequently, the Board, which must try to cater to many different users while considering the burdens placed on those who have to provide information, constantly treads a fine line between requiring disclosure of too much or too little information.

The hierarchy separates user-specific qualities, for example, understandability, from qualities inherent in information.  Information cannot be useful to decision makers who cannot understand it, even though it may otherwise be relevant to a decision and be reliable.  However, understandability of information is related to the characteristics of the decision maker as well as the characteristics of the information itself and, therefore, understandability cannot be evaluated in overall terms but must be judged in relation to a specific class of decision makers.

Primary Decision-Specific Qualities

Relevance and reliability are the two primary qualities that make accounting information useful for decision making.  Subject to constraints imposed by cost and materiality, increased relevance and increased reliability are the characteristics that make information a more desirable commodity--that is, one useful in making decisions.  If either of those qualities is completely missing, the information will not be useful.  Though, ideally, the choice of an accounting alternative should produce information that is both more reliable and more relevant, it may be necessary to sacrifice some of one quality for a gain in another.

To be relevant, information must be timely and it must have predictive value or feedback value or both.  To be reliable, information must have representational faithfulness and it must be verifiable and neutral.  Comparability, which includes consistency, is a secondary quality that interacts with relevance and reliability to contribute to the usefulness of information.  Two constraints are included in the hierarchy, both primarily quantitative in character.  Information can be useful and yet be too costly to justify providing it.  To be useful and worth providing, the benefits of information should exceed its cost.  All of the qualities of information shown are subject to a materiality threshold, and that is also shown as a constraint.

Relevance

• Relevant accounting information is capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct prior expectations.  Information can make a difference to decisions by improving decision makers' capacities to predict or by providing feedback on earlier expectations.  Usually, information does both at once, because knowledge about the outcomes of actions already taken will generally improve decision makers' abilities to predict the results of similar future actions.  Without a knowledge of the past, the basis for a prediction will usually be lacking.  Without an interest in the future, knowledge of the past is sterile.

• Timeliness, that is, having information available to decision makers before it loses its capacity to influence decisions, is an ancillary aspect of relevance.  If information is not available when it is needed or becomes available so long after the reported events that it has no value for future action, it lacks relevance and is of little or no use.  Timeliness alone cannot make information relevant, but a lack of timeliness can rob information of relevance it might otherwise have had.

Reliability

• The reliability of a measure rests on the faithfulness with which it represents what it purports to represent, coupled with an assurance for the user that it has that representational quality.  To be useful, information must be reliable as well as relevant.  Degrees of reliability must be recognized.  It is hardly ever a question of black or white, but rather of more reliability or less.  Reliability rests upon the extent to which the accounting description or measurement is verifiable and representationally faithful.  Neutrality of information also interacts with those two components of reliability to affect the usefulness of the information.  

• Verifiability is a quality that may be demonstrated by securing a high degree of consensus among independent measurers using the same measurement methods.  Representational faithfulness, on the other hand, refers to the correspondence or agreement between the accounting numbers and the resources or events those numbers purport to represent.  A high degree of correspondence, however, does not guarantee that an accounting measurement will be relevant to the user's needs if the resources or events represented by the measurement are inappropriate to the purpose at hand.  

• Neutrality means that, in formulating or implementing standards, the primary concern should be the relevance and reliability of the information that results, not the effect that the new rule may have on a particular interest.  A neutral choice between accounting alternatives is free from bias towards a predetermined result.  The objectives of financial reporting serve many different information users who have diverse interests, and no one predetermined result is likely to suit all interests.

Comparability and Consistency

• Information about a particular enterprise gains greatly in usefulness if it can be compared with similar information about other enterprises and with similar information about the same enterprise for some other period or some other point in time.  Comparability between enterprises and consistency in the application of methods over time increases the informational value of comparisons of relative economic opportunities or performance.  The significance of information, especially quantitative information, depends to a great extent on the user's ability to relate it to some benchmark.

Materiality

• Materiality is a pervasive concept that relates to the qualitative characteristics, especially relevance and reliability.  Materiality and relevance are both defined in terms of what influences or makes a difference to a decision maker, but the two terms can be distinguished.  A decision not to disclose certain information may be made, say, because investors have no need for that kind of information (it is not relevant) or because the amounts involved are too small to make a difference (they are not material).  Magnitude by itself, without regard to the nature of the item and the circumstances in which the judgment has to be made, will not generally be a sufficient basis for a materiality judgment.  The Board's present position is that no general standards of materiality can be formulated to take into account all the considerations that enter into an experienced human judgment.  Quantitative materiality criteria may be given by the Board in specific standards in the future, as in the past, as appropriate.

Costs and Benefits

• Each user of accounting information will uniquely perceive the relative value to be attached to each quality of that information.  Ultimately, a standard-setting body has to do its best to meet the needs of society as a whole when it promulgates a standard that sacrifices one of those qualities for another; and it must also be aware constantly of the calculus of costs and benefits.  In order to justify requiring a particular disclosure, the perceived benefits to be derived from that disclosure must exceed the perceived costs associated with it.  However, to say anything precise about their incidence is difficult. 

• There are costs of using information as well as of providing it; and the benefits from providing financial information accrue to preparers as well as users of that information.  Though it is unlikely that significantly improved means of measuring benefits will become available in the foreseeable future, it seems possible that better ways of quantifying the incremental costs of regulations of all kinds may gradually be developed, and the Board will watch any such developments carefully to see whether they can be applied to financial accounting standards.  The Board cannot cease to be concerned about the cost-effectiveness of its standards.  To do so would be a dereliction of its duty and a disservice to its constituents.