THE QUALITATIVE CHARACTERISTICS part 3

THE QUALITATIVE CHARACTERISTICS part 3

Neutrality

QC27. Neutrality is the absence of bias intended to attain a predetermined result or to induce a particular behavior. Neutrality is an essential aspect of faithful representation because biased financial reporting information cannot faithfully represent economic phenomena.

QC28. Neutrality is incompatible with conservatism, which implies a bias in financial reporting information. Neutral information does not color the image it communicates to influence behavior in a particular direction. For example, automobiles might be produced with speedometers that indicate a higher speed than the automobile actually is traveling at to influence drivers to obey the speed limit. But those “conservative” speedometers would be unacceptable to drivers who expect them to faithfully represent the speed of the automobile. Conservative or otherwise biased financial reporting information is equally unacceptable.

QC29. However, to say that financial reporting information should be neutral does not mean that it should be without purpose or that it should not influence behavior. On the contrary, relevant financial reporting information, by definition, is capable of influencing users’ decisions. Financial reporting information influences behavior, as do the results of elections, school examinations, and lotteries. Elections, examinations, and lotteries are not unfair—do not lack neutrality—merely because some people win and others lose. So it is with neutrality in financial reporting.

QC30. For example, some constituents told standard setters that requiring recognition of the cost of all employee share options would have a greater effect on some entities than on others. Therefore, some entities might win while others lose in terms of the effect on their relative cost of capital. Others said that a requirement to recognize the cost of all employee share options would cause some entities either to cease granting share options or to change the nature of the options they grant. None of those potential effects imply that the information resulting from recognizing the cost of employee share options would lack neutrality. On the contrary, the information would lack neutrality if standard setters had designed the requirements to eliminate the potential effect on particular types of entities, to encourage entities to award particular types of options, or otherwise to favor—in effect, to grant an accounting subsidy to—particular entities or particular types of compensation.

QC31. The consequences of a new financial reporting standard may indeed be bad for some interests in either the short or long term. But the dissemination of unreliable and potentially misleading information is, in the long run, bad for all interests. The responsibility of standard setters is to the integrity of the financial reporting system—a responsibility that could not be fulfilled if a standard setter changed direction with every change in the political wind. Politically motivated standards would quickly lose their credibility. They would also cast doubt on the credibility of all standards, including those that provide decision-useful financial reporting information as judged by the qualitative characteristics.

Completeness

QC32. Completeness means including in financial reporting all information that is necessary for faithful representation of the economic phenomena that the information purports to represent. Therefore, completeness, within the bounds of what is material and feasible, considering the cost, is an essential component of faithful representation.

QC33. The importance of completeness is clear in the context of a line item on a financial statement. For example, to omit some revenues during the period from the item revenues on a statement of income (or profit or loss) would faithfully represent neither that item nor subsequent subtotals and totals. Completeness is also important in developing estimates of economic phenomena, such as in estimating fair value using a valuation technique. For example, estimating the fair value of a financial instrument using a pricing model must take into account all of the economic factors that are valid inputs to the model used. Thus, to omit dividends expected to be paid on the underlying shares over the term of a call or put option on those shares would not faithfully represent the fair value of the option.

QC34. Ideally, an entity’s financial report should include everything about the entity that is necessary to understand the effects of all economic phenomena that are pertinent to users’ investment, credit, and similar resource allocation decisions. Completeness, however, is relative because financial reports cannot show everything. To try to include in financial reports everything that any potential user might want would not be cost beneficial (paragraphs QC53–QC59) and might conflict with other desirable characteristics, such as understandability (paragraphs QC39–QC41). In addition, as discussed in paragraph OB14, those who use financial reports in making resource allocation decisions must also take into account information from other sources, for example, industry information about general supply and demand factors for an entity’s products and potential technological innovations.

Comparability (Including Consistency)

QC35. Comparability, including consistency, enhances the usefulness of financial reporting information in making investment, credit, and similar resource allocation decisions. Comparability is the quality of information that enables users to identify similarities in and differences between two sets of economic phenomena. Consistency refers to use of the same accounting policies and procedures, either from period to period within an entity or in a single period across entities. Comparability is the goal; consistency is a means to an end that helps in achieving that goal.

QC36. The essence of investment, credit, and similar resource allocation decisions is choosing between alternatives, such as whether to buy shares in Entity A or in Entity B. Thus, information about an entity gains greatly in usefulness if it can be compared with similar information about other entities and with similar information about the same entity for some other period or some other point in time. Comparability is not a quality of an individual item of information, but rather a quality of the relationship between two or more items of information.

QC37. Comparability sometimes has been confused with uniformity. For information to be comparable, like things must look alike and different things must look different. An overemphasis on uniformity, for example, requiring all entities to use the same assumptions on economic factors such as the expected future dividend rate on their shares as inputs to a valuation model, may reduce comparability by making unlike things look alike. Comparability of financial reporting information is not enhanced by making unlike things look alike any more than it is by making like things look different.

QC38. Permitting alternative accounting methods for the same transactions or other events (real-world economic phenomena) is undesirable because to do so diminishes comparability and may diminish other desirable qualities as well, for example, faithful representation and understandability. Regardless of its importance, however, comparability alone cannot make information useful for decision making. Standard setters may conclude that a temporary reduction in comparability is worthwhile to improve relevance or faithful representation (or both) in the longer term. For example, a temporary reduction in period-to-period consistency, and thus in comparability, occurs when a new financial reporting standard requires a change to a method that improves relevance or faithful representation. Such a change in reporting effectively trades a temporary reduction in period-to-period consistency for greater comparability in the future. In that situation, appropriate disclosures can help to compensate for the temporary reduction in comparability.

Understandability

QC39. Understandability is the quality of information that enables users who have a reasonable knowledge of business and economic activities and financial reporting, and who study the information with reasonable diligence, to comprehend its meaning. (Paragraphs QC3 and QC4 discuss standard setters’ expectations of users of financial reporting information. The quality of understandability is defined in relation to users who satisfy those expectations.) Relevant information should not be excluded solely because it may be too complex or difficult for some users to understand. Understandability is enhanced when information is classified, characterized, and presented clearly and concisely. Comparability also enhances understandability.

QC40. Information cannot influence a particular user’s decision unless it is presented in a manner that the user can understand. However, information may be relevant to a situation even though some people who confront the situation cannot understand it—at least not without help. For example, a traveler in a foreign country may have trouble ordering from a menu printed in an unfamiliar language. The listing of items on the menu is relevant to the decision, but the traveler may not be able to use that information unless it is translated into a language that the traveler understands. Thus, information may not be useful to a particular user even though it is relevant to the situation the user faces.

QC41. Similar situations arise frequently in financial reporting. For example, investors or creditors unfamiliar with actions an entity might take to hedge its exposure to financial risks might have difficulty understanding a note to the financial statements that explains its hedging activities and how those activities are reflected in its financial report. That information, however, is relevant to decisions about the entity and should be understandable to users who have a reasonable knowledge of hedging activities and who read and consider the information with reasonable diligence. The understandability of information about hedging activities and related hedge accounting might be improved by a standard setter requiring, or an entity voluntarily providing, tabular or graphic formats (or both), as well as narrative explanations. However, conciseness is essential because to overwhelm users with unnecessarily lengthy narratives or unnecessary information can rob even relevant and representationally faithful information of its decision usefulness. Standard setters, together with those who prepare financial reports, should take whatever steps are necessary and feasible to improve the clarity and conciseness of financial reporting information so that the intended users (paragraph QC4) can understand it.