In this tutorial, we will learn about the qualitative characteristics of financial statements. The information must be relevant to the needs of the users, which is when the info influences their economic decisions.
Qualitative characteristics are the attributes that make the information provided in financial statements useful to users. The following are the essential qualitative characteristics of the financial statements:
Understandability:
The users must readily understand the essential quality of the financial statements. For this, it has been assumed that users have sufficient knowledge of the business and economic activities.
Relevance:
It is useful; a financial statement must have information relevant to the users, i.e., the data presented in the balance sheet may have concern and significance to the account’s user, so that they can make rational decisions accordingly. And no such item is left out which can manipulate the figures of the profit and loss.
Reliability:
User accounts make decisions by seeing the balance sheet and profit & loss statement, so it must be accurate, and the information must be reliable. Any misleading figure can cause a significant loss, and it is considered as fraud or misrepresentation.
Comparability:
Users must be able to compare the financial statements of two different fiscal years to identify trends in financial position, past performance, and cash flows. They must also analyze the financial statements of two various enterprises to evaluate the economic situation, performance, and cash flows.
Materiality:
The relevance of information is affected by its materiality. Information is material if it is a misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken based on the financial report. Materiality depends upon the size and nature of the error, judged in the particular circumstances. It is a cut-off instead of being and qualitative characteristic.
Faithful Representation:
Maybe reliable, information must represent the transactions and other events faithfully. For example, a balance sheet must accurately describe the liabilities “owed” by the enterprise and assets “owned” by the enterprise. Most of the financial transactions or events are subject to some risk of being less faithful representation, such as goodwill. Every firm builds goodwill internally over time; however, it is difficult to measure that goodwill reliably. There always a risk of being less faithful representation.
Substance Over Form:
If the information is presented faithfully, then they should be recorded and accounted for and presented with their substantial and economic reality, not merely their legal form. For example, the benefits or rights in immovable property transfer, but the documentation is pending, and then the recording of acquisition would in substance represent the transaction entered.
Neutrality:
May be reliable, the information should remain free from bias. Financial statements are not neutral if, by selecting or presenting information, influence decision making and the final judgment.
Prudence:
The financial statement must be prudent, i.e., judgment about the future losses which are to be guarded and the uncertain gains—the creations of reserves and provisions made due to prudence.
Full, fair, and adequate disclosure:
The financial statements of an enterprise must disclose the fair, the whole, and the proper information to the internal and external users, which will help them to make reasonable and rational decisions.
The principle of full disclosure implies that all the essential items are recorded and disclosed in financial statements in detail. This concept is widely used in organizations due to the separation of ownership and management. According to this, the Companies Act, 2013, came out with the Perform of the balance sheet, profit, and loss account.
Completeness:
The financial statement to be reliable must be complete within the bounds of materiality and cost. An omission in the financial statement can cause the information to be false, misleading, unreliable, and deficient in its relevance. Thus, data is present faithfully, so the transactions and events are to be recorded by their substance over their legal form.
For example, a company has sold its machinery, but it still uses it by making so arrangements with the buyer of the mechanism. Undoubtedly, it is a legal transaction, but the economic reality is that the company is still deriving profit from the machinery which has no record on the balance sheet.
May be reliable, the balance sheet should be free from bias and be neutral to avoid future uncertainties; the financial statements are to made with prudence, i.e., creating required provisions and reserves.