The quality of information contained in financial statements determine the usefulness of these statements. It is important to know the difference between accounting policies and accounting principles. Four factors can be used to measure this quality of information, they are - relevance, reliability, comparability and understandability.
Financial statements provide information about a business's financial position. These can be used as the basis for financial decisions to be made: information not available when required is of little use.
It is important that the information is relevant to users of the financial statements. This means that it can used to confirm, or correct, prior expectations about past events and also to help forming, revising or confirming expectations about the future.
The information provided in financial statements can be reliable if it has the following features:
- Capable of being absolutely depended upon by users of the statements as being a true representation of the underlying transactions and events which it is supposed to represent.
- Capable of being verified independently by users of the information
- Free from bias.
- Free from significant errors.
- Prepared with appropriate caution being applied to any judgements and estimates which are needed.
The contents of the financial statements of a business can only be useful if it can be compared with similar information concerning the same business for another accounting period. It is also useful if you can compare the information with similar information about other business.
In order to make comparisons, it is important to be aware of any different policies which are used in the preparation of the financial statements, any changes in these policies and the effect of such changes. It is necessary to be able to identify the differences and similarities between the contents of the the financial statements and the information relating to the other accounting periods or other businesses.
It is very important that financial statements can be easily understood by the users of those statements. This depends, to some extent but not completely on the clarity of the information provided.
It also depends on the ability of the users of the financial statements. It is usually assumed that users of financial statements have a vast knowledge of business, economic activities and accounting and that they will be very diligent when studying the financial statements. However, information should not be omitted from financial statements because it is decided that it is too difficult for users to understand.
TEST YOUR UNDERSTANDING
1. State two ways in which information can be regarded as being relevant
2. State three ways in which information can be regarded as reliable
3. Explain why it is necessary to know any changes in accounting policy when comparing financial statements with those of a previous year.
4. Explain the meaning of the term "understandability"