Primary Qualities of Accounting Information: Relevance and Reliability
Relevance and reliability are the two primary qualities that make accounting information useful for decision making. As stated in FASB Concepts Statement No. 2, “the qualities that distinguish ‘better’ (more useful) information from ‘inferior’ (less useful) information are primarily the qualities of relevance and reliability, with some other characteristics that those qualities imply.”
Relevance. To be relevant, accounting information must be capable of making a difference in a decision. Information with no bearing on a decision is irrelevant. Relevant information helps users predict the ultimate outcome of past, present, and future events. That is, it has predictive value. Relevant information also helps users confirm or correct prior expectations; it has feedback value.
Reliability. Accounting information is reliable to the extent that it is verifiable, is a faithful representation, and is reasonably free of error and bias. Reliability is a necessity, because most users have neither the time nor the expertise to evaluate the factual content of the information.
Verifiability occurs when independent measurers, using the same methods, obtain similar results. For example, would several independent auditors reach the same conclusion about a set of financial statements? If not, then the statements are not verifiable. Auditors could not render an opinion on such statements.
Representational faithfulness means that the numbers and descriptions match what really existed or happened. If JP Morgans’ income statement reports sales of $225 billion when it had sales of $193.5 billion, then the statement fails to faithfully represent the proper sales amount.
Neutrality means that a company cannot select information to favor one set of interested parties over another. Unbiased information must be the overriding consideration. For example, in the notes to financial statements, tobacco companies such as British Tobacco should not suppress information about the numerous lawsuits that have been filed because of tobacco-related health concerns—even though such disclosure is damaging to the company.
Secondary Qualities of Accounting Information: Comparability and Consistency
Information about a company is more useful if decision makers can compare it with similar information about another company and with similar information about the same company at other points in time. The first of these qualities is comparability, and the second is consistency.
Comparability. Information that is measured and reported in a similar manner for different companies is considered comparable. Comparability enables users to identify the real similarities and differences in economic events between companies.
Consistency. When a company applies the same accounting treatment to similar events, from period to period, the company shows consistent use of accounting standards. The idea of consistency does not mean, however, that companies cannot switch from one accounting method to another. A company can change methods, but it must first demonstrate that the newly adopted method is preferable to the old. If approved, the company must then disclose the nature and effect of the accounting change, as well as the justification for it, in the financial statements for the period in which it made the change.
Secondary Qualities of Accounting Information: Comparability and Consistency
Information about a company is more useful if decision makers can compare it with similar information about another company and with similar information about the same company at other points in time. The first of these qualities is comparability, and the second is consistency.
Comparability. Information that is measured and reported in a similar manner for different companies is considered comparable. Comparability enables users to identify the real similarities and differences in economic events between companies.
Consistency. When a company applies the same accounting treatment to similar events, from period to period, the company shows consistent use of accounting standards. The idea of consistency does not mean, however, that companies cannot switch from one accounting method to another. A company can change methods, but it must first demonstrate that the newly adopted method is preferable to the old. If approved, the company must then disclose the nature and effect of the accounting change, as well as the justification for it, in the financial statements for the period in which it made the change.