Fia Ffa Chapter 3

FIA-FFA- FINANCIAL ACCOUNTING REFERENCE- CHAPTER 3

THE QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION

Introduction to the Fr!e"or#

 The Framework Framework for the preparation and presentation of nancial statements is a set of principles which underpin the foundations of nancial accounting. It is a conceptual framework upon which all lFRSs are based and hence which determines how nancial statements are prepared and the information they contain. The Framework is not an accounting standard in itself. itself.  The Framework deals with: (a (a The The ob!e ob!ect cti" i"e e of nan nanci cial al st stat atem emen ents ts (b The #ual #ualita itati" ti"e e charact characteri eristi stics cs that that determ determine ine the the usefulness of information in nancial statements (c (c The The den denit itio ion$ n$ reco recogn gniti ition on and and meas measur urem emen entt of the elements from which nancial statements are constructed (d %oncep %oncepts ts of of capit capital al and capita capitall main maintena tenance nce  The Framework sets out two important underlying assumptions for nancial statements$ the going concern concept and the accruals basis. &oing concern  This concept assumes that$ when preparing a normal set of accounts$ the business will continue to operate in appro'imately the same manner for the foreseeable future (at least the ne't ) months. In particular$ the entity will not go into li#uidation or scale down its operations in a material way w ay..  The main signicance of the going concern concept is that the assets should not be "alues at their *break+up* "alue (the amount they would sell for if they were sold o, piecemeal and the business were broken up. If the going concern assumption is not followed$ that fact must be disclosed$ together with the following information. (a The basis on which the nancial statements ha"e been been prepared. (b The reasons reasons why the entity is not considered considered to be a going



concern. -ccruals basis  The e,ects of transactions and other e"ents are recognised when they occur (and not as cash or its e#ui"alent is recei"ed or paid and they are recorded in the accounting records and reported in the nancial statements of the periods to which they relate. -ccording to the accruals assumption$ in computing prot re"enue earned must be matched against the e'penditure incurred in earning it. This is also known as the matching con"ention

•

•

The #ualitati"e characteristics of nancial information  The four principal #ualitati"e characteristics are understandability$ rele"ance$ reliability and comparability. ther important #ualitati"e characteristics and concepts include fair presentation$ consistency and the business entity concept. /nderstandability /sers must be able to understand nancial statements. They are assumed to ha"e some business$ economic and accounting knowledge and to be able to apply themsel"es to study the information properly. %omple' matters should not be left out of nancial statements simply due to their di0culty if the information is rele"ant. Rele"ance Information has the #uality of rele"ance when it in1uences the economic decisions of users by helping them e"aluate past$ present or future e"ents or conrming$ or correcting$ their past e"aluations. Information should be released on a timely basis to be rele"ant to users.  The rele"ance of information is a,ected by its nature and materiality. Information is material if its omission or misstatement could in1uence the economic decisions of users taken on the basis of the nancial statements. In preparing accounts it is important to assess what is material and what is not$ so that time and money are not wasted in the pursuit of e'cessi"e detail.

)

2etermining whether or not an item is material is a "ery sub!ecti"e e'ercise. There is no absolute measure of materiality. It is common to apply a con"enient rule of thumb (for e'ample material items are those with a "alue greater than 34 of net prots. 5owe"er some items disclosed in the accounts are regarded as particularly sensiti"e and e"en a "ery small misstatement of such an item is taken as a material error. -n e'ample$ in the accounts of a limited liability company$ is the amount of remuneration (salaries and other rewards paid to directors of the company.

Reliability Information must also be reliable to be useful. The user must be able to depend on it being a faithful representation. Information has the #uality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be e'pected to represent Faithful representation Information must represent faithfully the transactions it purports to represent in order to be reliable. There is a risk that this may not be the case$ not due to bias$ but due to inherent di0culties in identifying the transactions or nding an appropriate method of measurement or presentation. 6here measurement of the nancial e,ects of an item is so uncertain$ enterprises should not recognise such an item Substance o"er form   The principle that transactions and other e"ents are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. For instance$ one party may sell an asset to another party and the sales documentation may record that legal ownership has been transferred. 5owe"er$ if agreements e'ist whereby the party selling the asset continues to en!oy the future economic benets arising from the asset$ then in substance no sale has taken place. 7eutrality   

8

Information must be free from bias to be reliable. 7eutrality is lost if the nancial statements are prepared so as to in1uence the user to make a !udgement or decision in order to achie"e a predetermined outcome. 9rudence     This is the inclusion of a degree of caution in the e'ercise of the  !udgements needed in making the estimates re#uired under conditions of uncertainty$ such that assets or income are not o"erstated liabilities or e'penses are not understated. 9rudence must be e'ercised when preparing nancial statements because of the uncertainty surrounding many transactions. It is not permitted$ howe"er$ to create secret or hidden reser"es using prudence as a !ustication.  There are three important issues to bear in mind. (a 6here alternati"e procedures or "aluations are possible$ the one selected should be the one which gi"es the most cautious result. (b 6here a loss is foreseen$ it should be anticipated and taken into account immediately. "en when the e'act amount of the loss is not known$ an estimate of the loss should be made$ based on the best information a"ailable. If a business purchases in"entory for ;$)