How the Qualitative Characteristics Relate to the Objective of Financial Reporting and to Each Other

How the Qualitative Characteristics Relate to the Objective of Financial Reporting and to Each Other

QC42. The objective of financial reporting is to provide information that is useful to present and potential investors and creditors and others in making investment, credit, and similar resource allocation decisions. Each qualitative characteristic discussed in this chapter makes its own distinct contribution to the decision usefulness of financial reporting information. The discussion in paragraphs QC43–QC47 considers both the contributions of, and the relationships among, the qualitative characteristics of financial reporting information. The discussion takes as its starting point that investors, creditors, and other users of financial reports wish to understand economic phenomena that are pertinent to their decisions.

QC43. The qualitative characteristic of relevance is concerned with the connection of economic phenomena to the decisions of investors, creditors, and other users of financial reporting information—the pertinence of the phenomena to those decisions. Application of the qualitative characteristic of relevance will identify which economic phenomena should be depicted in financial reports, with the intent of providing decision-useful information about those phenomena. Economic phenomena about which information is useful for making those decisions are relevant, and phenomena about which information is not useful are irrelevant. Logically, then, relevance must be considered before the other qualitative characteristics because relevance determines which economic phenomena should be depicted in financial reports.

QC44. In logical order, the next qualitative characteristic to be applied is faithful representation. Once relevance is applied to determine which economic phenomena are pertinent to the decisions to be made, faithful representation is applied to determine which depictions of those phenomena provide the best correspondence of relevant phenomena with their representations. (Considering faithful representation after relevance does not mean that faithful representation is secondary to relevance. Rather, relevance is considered first because it would be illogical to consider how to faithfully represent a phenomenon that is not pertinent—information about it is not relevant—to the decisions of users of financial reports.) Application of the faithful representation characteristic determines whether a proposed depiction in words and numbers is faithful (or unfaithful) to the economic phenomena being depicted. Faithful depictions of relevant phenomena can be decision useful; unfaithful depictions will be either useless for making decisions or misleading.

QC45. The qualitative characteristics of relevance and representational faithfulness contribute to decision usefulness in different ways. Thus, they work in concert with one another. Both relevance and faithful representation are necessary because a depiction is decision useful only if it faithfully represents an economic phenomenon that is relevant to investment and credit decisions. A depiction that is a faithful representation of an irrelevant phenomenon is not decision useful, just as a depiction that is an unfaithful representation of a relevant phenomenon is not decision useful. Thus, either irrelevance (the economic phenomenon is not connected to the decision to be made) or unfaithful representation (the depiction is not connected to the phenomena) results in information that is not decision useful. Together, relevance and faithful representation make financial reporting information decision useful.

QC46. The next qualitative characteristics in logical order after faithful representation are comparability and understandability. They enhance the decision usefulness of financial reporting information that is relevant and representationally faithful. For example, comparability can enhance the decision usefulness of information because comparable information helps users to detect similarities and differences in the underlying economic phenomena. Understandability can enhance the decision usefulness of information because it helps users to better comprehend the meaning of that information. However, comparability and understandability cannot, either individually or in concert with each other, make information decision useful if it is irrelevant or not faithfully represented.

QC47. The qualitative characteristics are complementary concepts in achieving decision-useful financial reporting information; their application, in concert, should maximize the usefulness of financial reports. However, standard setters sometimes may need to compromise on one or more of those characteristics because of cost-benefit considerations or technical feasibility issues. Cost-benefit considerations may, for example, cause standard setters to adopt a less relevant or less representationally faithful depiction to reduce the costs of preparing financial reporting information. (See paragraphs QC53–QC59.) Nevertheless, the purpose of the qualitative characteristics (and the rest of the conceptual framework) is to identify the ideals toward which to strive.