Question Tag: Comparability

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  • 10 Marks

FR – April 2022 – L2 – Q5a – Conceptual Framework for Financial Reporting

Justify how qualitative characteristics of financial information apply to tangible non-current assets using examples.

The IASB’s Conceptual Framework identifies, among others, the qualitative characteristics of relevance, faithful representation, comparability, and understandability.

Required:
Justify with an example each how the qualitative characteristics will apply to the treatment of tangible non-current assets. (10 marks)

Qualitative characteristics as applicable to tangibles non-current assets illustrated by IAS 16
Relevance:
Example: Choosing the revaluation model for tangible non-current assets like property provides relevant information as it reflects the current market value, aiding users in decision-making based on up-to-date information. For instance, if a company chooses to revalue its land and buildings to their fair value, it provides information that is more relevant for users assessing the company’s financial position.

Faithful Representation:
Example: Using the cost model ensures faithful representation as it records assets based on historical cost, which is verifiable and objective. For example, if a company uses the cost model for its machinery, the value in the financial statements reflects the original purchase cost less accumulated depreciation, representing the actual cash spent.

Comparability:
Example: Adopting the same depreciation method for all tangible non-current assets within a class enhances comparability. For example, if a company uses the straight-line method to depreciate all its machinery, users can compare the performance of different years and other companies using the same method.

Understandability:
Example: Disclosing the depreciation method and rate for each class of assets in the financial statements improves understandability. For instance, explaining that buildings are depreciated over 20 years on a straight-line basis helps users understand the impact of depreciation on financial performance.
(10 marks)

  • 6 Marks

FR – Nov 2015 – L2 – Q4a – Conceptual Framework for Financial Reporting

This question asks for an explanation of the qualitative characteristics of understandability and comparability in financial reporting, along with the role of consistency in comparability.

(a) Two of the enhancing qualitative characteristics of useful financial information contained in the IASB’s Conceptual Framework for Financial Reporting are understandability and comparability.

Required:
Explain the meaning and purpose of the above characteristics in the context of financial reporting and discuss the role of consistency within the characteristic of comparability in relation to changes in accounting policy. (6 marks)

(a) Understandability
Financial information is intended to assist users in making economic decisions. For this purpose, it is important that financial information is presented in a form that users can understand. However, this does not mean that complex matters which some users may find difficult to understand, and which some directors may like an excuse to exclude, should be left out of financial statements. Reports from which data has been excluded could be incomplete and misleading. The Conceptual Framework states that users can be assumed to have reasonable knowledge of business and economic activities and be prepared to review and analyze the information diligently.

Comparability
In understanding the financial performance of an entity, users will want to compare its results with those of other entities in the same sector and with its own results for previous periods. The concept of comparability is, therefore, very important. Comparison between entities is made more possible by IFRSs in which most allowed alternatives have been removed and by the requirement to disclose accounting policies. So, if two entities have applied different accounting policies, users can be aware of that and allow for it.

Comparing an entity’s results with its performance in prior years requires the application of consistency. An entity should treat financial items and transactions in a consistent manner from year to year, by applying the same accounting policies. Where there is a change of accounting policy from one year to the next, the comparative information must be restated to show what the results for the previous year would have been if the new accounting policy had been applied. The statement of changes in equity also shows the effect on the previous year’s equity balances of the change of accounting policy. The user is therefore able to adjust for the change of accounting policy and observe the changes in underlying performances.

  • 5 Marks

CR – May 2016 – L3 – Q4b – Accounting and reporting concepts

Discuss the concepts of relevance, faithful representation, and comparability, and how they make financial information useful to users of financial statements.

The qualitative characteristics of relevance, faithful representation and comparability identified in the IASB’s Framework for the preparation and presentation of financial statements (Framework) are some of the attributes that make financial information useful to the various users of financial statements.

Required: Discuss the concept of relevance, faithful representation and comparability and how they make financial information useful.

i) Relevance

Information has the quality of relevance when it can influence, on a timely basis, users’ economic decisions. It helps to evaluate past, present and future events by confirming or perhaps correcting past evaluations of economic events. There are many ways of interpreting and applying the concept of relevance, for example, only material information is considered relevant as, by definition, information is material only if its omission or misstatement could influence users. Another common debate regarding relevance is whether current value information is more relevant than that based on historical cost. An interesting emphasis placed on relevance within the Framework is that relevant information assists in the predictive ability of financial statements.

That is not to say the financial statements should be predictive in the sense of forecasts, but that (past) information should be presented in a manner that assists users to assess an entity’s ability to take advantage of opportunities and react to adverse situations. A good example of this is the separate presentation of discontinued operations in the income statement. From this users will be better able to assess the parts of the entity that will produce future profits (continuing operations) and users can judge the merits of the discontinuation ie has the entity sold a profitable part of the business (which would lead users to question why), or has the entity acted to curtail the adverse effect of a loss making operation.

(ii) Faithful representation

The Framework states that for information to be useful it must be reliable. The quality of reliability is described as being free from material error (accurate) and a faithful representation of that which it purports to portray (i.e. the financial statements are a faithful representation of the entity’s underlying transactions). There can be occasions where the legal form of a transaction can be engineered to disguise the economic reality of the transaction. A cornerstone of faithful representation is that transactions must be accounted for according to their substance (i.e. commercial intent or economic reality) rather than their legal or contrived form. To represent faithfully, information must be neutral (free from bias). Biased information attempts to influence users (perhaps to come to a predetermined decision) by the manner in which it is presented. It is recognized that financial statements cannot be absolutely accurate due to inevitable uncertainties surrounding their preparation. A typical example would be estimating the useful economic lives of non-current assets. This is addressed by the use of prudence which is the exercise of a degree of caution in matters of uncertainty. However prudence cannot be used to deliberately understate profit or create excessive provisions (this would break the neutrality principle). Reliable information must also be complete, omitted information (that should be reported) will obviously mislead users.

(iii) Comparability

Comparability is fundamental to assessing an entity’s performance. Users will compare an entity’s results over time and also with other similar entities. This is the principal reason why financial statements contain corresponding amounts for previous period(s). Comparability is enhanced by the use (and disclosure) of consistent accounting policies such that users can confirm that comparative information (for calculating trends) is comparable and the disclosure of accounting policies at least informs users if different entities use different policies. That said, comparability should not stand in the way of improved accounting practices (usually through new Standards); it is recognized that there are occasions where it is necessary to adopt new accounting policies if they would enhance relevance and reliability.

  • 4 Marks

PSAF – May 2017 – L2 – Q4b – General purpose financial reporting framework

This question explains the qualitative characteristics that the financial statement may lack.

Given the information available, explain TWO qualitative characteristics of a general purpose financial report that the financial statement you have prepared in question (a) lacked. (4 marks)

Two qualitative characteristics that the financial statement may lack are:

  1. Comparability:
    • Explanation: The financial statements lack comparability because no previous year’s figures or budget information are presented alongside the current data. This makes it difficult to compare the performance year-over-year or against budget expectations.
  2. Timeliness:
    • Explanation: The financial statement relates to the year 2014 but was prepared in 2016, which means the information is outdated. Timeliness is crucial as it affects the usefulness of the financial information. Reports should be prepared and presented as soon as possible after the end of the reporting period.
  3. Understandability:
  • Explanation: For the financial statement to be understandable it should
    contain notes including the disclosure of accounting policies. However, the
    financial statement prepared does not contain any notes or disclosure in
    accounting policies therefore it lacks understandability.

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