CHAPTER 3: CONCEPTUAL FRAMEWORK – QUALITATIVE CHARACTERISTICS

Qualitative characteristics

Qualitative characteristics are the qualities or attributes that make financial accounting information useful to the
users.

Under the Conceptual Framework for Financial Reporting, qualitative characteristics are classified into fundamental
qualitative characteristics and enhancing qualitative characteristics.

Fundamental qualitative characteristics

The fundamental qualitative characteristics relate to the content or substance of financial information.

Information must be both relevant and faithfully represented if it is to be useful.

Application of qualitative characteristics

The most efficient and effective process of applying the fundamental qualitative characteristics would usually be:

First, identify an economic phenomenon that has the potential to be useful.

Second, identify the type of information about the phenomenon that would be most relevant and can be faithfully
represented.

Third, determine whether the information is available.

Relevance

Relevance is the capacity of the information to influence a decision. Information that does not bear on an economic
decision is useless.

Ingredients of relevance

Financial information is capable of making a difference in a decision if it has predictive value and confirmatory value.

Financial information has predictive value if it can be used as an input to processes employed by users to predict future
outcome.

Financial information has confirmatory value if it provides feedback about previous evaluations.

Often, information has both predictive and confirmatory value. The predictive and confirmatory roles of information are
interrelated.

Materiality

The materiality concept is also known as the doctrine of convenience. Materiality is really a quantitative “threshold”
linked very closely to the qualitative characteristic of relevance.

Materiality is a subquality of relevance based on the nature and magnitude or both of the items to which the
information relates.

When is an item material?

An item is material if knowledge of it could reasonably affect or influence the economic decision of the primary users
of the financial statements.

New definition of materiality

The IASB provided the following new definition of materiality.

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the
economic decisions that primary users of general purpose financial statements make on the basis of those statements
which provide financial information about a specific reporting entity.

The revised definition of materiality highlights three important aspects:

CHAPTER 3: CONCEPTUAL FRAMEWORK – QUALITATIVE CHARACTERISTICS

1. Could reasonably be expected to influence

2. Obscuring information
3. Primary users

Could reasonably be expected to influence

By including the term could reasonably be expected to influence in the new definition, material information shall be
limited to the economic decision of primary users rather than to all users which is too broad in scope.

Obscuring information

Information is obscured if presenting or communicating it would have a similar effect as omitting or misstating the
information. Obscuring information may be characterized by deliberate vagueness, ambiguity and obtruseness.

Examples of obscured material information are:

a) The language is vague or unclear.

b) The information is scattered throughout the financial statements.
c) Dissimilar items are aggregated inappropriately.
d) Similar items are disaggregated inappropriately.

Primary users

Only primary users of financial statements are considered because these groups are the users to whom general purpose
financial statements are primarily directed.

Factors of materiality

Materiality depends on the magnitude and nature of the financial information. In the exercise of judgment in determining
materiality, the relative size and nature of an item are considered.

The size of the item in relation to the total of the group to which the item belongs is taken into account.

The nature of the item may be inherently material because by its very nature it affects economic decision.

Faithful representation

Faithful representation means that financial reports represent economic phenomena or transactions in words and
numbers. It also means that the actual effects of the transaction shall be properly accounted for and reported in the
financial statements.

Ingredients of faithful representation

To be a perfectly faithful representation, a depiction should have three characteristics, namely:

1. Completeness
2. Neutrality
3. Free from error

Completeness

Completeness requires that relevant information should be presented in a way that facilitates understanding and avoids
erroneous implication. It is the result of adequate disclosure standard or the principle of full disclosure.

Standard of adequate disclosure

The standard of adequate disclosure means that all significant and relevant information leading to the preparation of
financial statements shall be clearly reported.

This is best described by disclosure of any financial facts significant enough to influence the judgment of informed users.

Notes to financial statements

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The purpose of the notes is to provide the necessary disclosures required by PFRS.

Notes to financial statements provide narrative description or disaggregation of the items presented in the financial
statements and information about items that do not qualify for recognition.

Neutrality

A neutral depiction is without bias in the preparation or presentation of financial information. It is not slanted, weighted,
emphasized, de-emphasized or otherwise manipulated to increase probability that financial information will be received
favorably or unfavorably by users.

Neutrality is synonymous with the all-encompassing principle of fairness. To be neutral is to be fair.

Prudence

The Revised Conceptual Framework has reintroduced the concept of prudence.

Prudence is the exercise of care and caution when dealing with the uncertainties in the measurement process such that
assets or income are not overstated and liabilities or expenses are not understated.

Conservatism

Conservatism means that when alternatives exist, the alternative which has the least effect on equity should be chosen. In
the simplest words, conservatism means “in case of doubt, record any loss and do not record any gain”.

Free from error

Free from error means there are no errors or omissions in the description of the phenomenon or transaction.

Measurement uncertainty

Measurement uncertainty arises when monetary amounts in financial reports cannot be observed directly and must
instead be estimated.

As long as the estimate is clearly and accurately described and explained, even a high level of measurement uncertainty
does not affect the usefulness of the financial information.

Substance over form

The economic substance of transactions and events are usually emphasized when economic substance differs from legal
form.

Example of substance over form

An example is when the lessee leased property from the lessor.

The terms of the lease provide that the lease transfers ownership of the asset to the lessee by the end of the lease term.

In form, the contract is a lease as popularly understood,

But in substance, in reality, if the “transfer of ownership provision” is to be considered, the real intent of the parties is an
installment purchase of an asset by the lessee from the lessor. Accordingly, the lessee shall record an acquisition of right
of use as an asset and set up a liability to the lessor.

The periodic rental is conceived as an installment payment representing interest and principal.

Enhancing qualitative characteristics

The enhancing qualitative characteristics are intended to increase the usefulness of the financial information that is
relevant and faithfully represented. It includes comparability, understandability, verifiability and timeliness.

Comparability

Comparability means the ability to bring together for the purpose of noting points of likeness and difference.
CHAPTER 3: CONCEPTUAL FRAMEWORK – QUALITATIVE CHARACTERISTICS

Consistency

Implicit in the qualitative characteristic of comparability is the principle of consistency. It refers to the use of the same
method for the same item, either from period to period within an entity or in a single period across entities.

Understandability

Understandability requires that financial information must be comprehensible or intelligible if it is to be most useful.

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who
review and analyze the information diligently.

Verifiability

Verifiability means that different knowledgeable and independent observers could reach consensus, although not
necessarily complete agreement, that a particular depiction is a faithful representation.

Types of verification

Verification can be direct or indirect.

Direct verification means verifying an amount or other representation through direct observation.

Indirect verification means checking the inputs to a model, formula or other technique and recalculating the inputs using
the same methodology.

Timeliness

Timeliness means that financial information must be available or communicated early enough when a decision is to be
made.

Generally, the older the information, the less useful. Timeliness enhances the truism that without knowledge of the past,
the basis for prediction will usually be lacking and without interest in the future, knowledge of the past is sterile.

Cost constraint on useful information

Reporting financial information imposes cost and it is important that such cost is justified by the benefit derived from the
financial information.

The benefit derived from the information should exceed the cost incurred in obtaining the information.

Assessing whether the cost of reporting outweighs or falls short of the benefit is difficult to measure and becomes a matter
of professional judgment.