Qualitative characteristics

From CEOpedia | Management online

Qualitative characteristics are meant to make financial information more advantageous to users. From an analytical point of view, qualitative characteristics can be differentiated into two groups: Fundamental and Enhancing qualitative characteristics. If a company does not have enough information, even managers may not know the real financial situation of their company, which may hinder or even prevent the operation of market disciplines. The use of qualitative characteristics and good accounting standards most often results in financial statements that provide reliable and true information (H. Greunding, M. Koen 2001, p. 3).

Fundamental Qualitative Characteristics

The key qualitative characteristics are (H. Greunding, M. Koen 2001, p. 3):

Relevance - "Information is relevant to a decision-making situation if it has the capacity to help a decision-maker to form, confirm or revise expectations about the future, or to confirm or correct prior expectations about past events." (D. Solomons 1997, p. 43). Relevant information has a great impact on users' economic decisions. Omission or distortion of relevant information may affect the economic decisions of users on which the company's future depends. The nature and relevance of the information affect its relevance.

Reliability - Reliable information is free from material error and bias. The information must not be misleading. It is guided by:

  • Substance over form,
  • Faithful representation,
  • Neutrality,
  • Completeness,
  • Prudence (H. Greunding, M. Koen 2001, p. 5-6).

There are often discussions where the term 'reliable' is considered synonymous with 'verifiable'. However, it is possible that all verifiers use faulty measuring instruments or faulty rules of measurement. In this situation, the information may be verified and still be incorrect. These words should not be used interchangeably (D. Solomons 1997, p. 44).

Comparability - Comparability enables users to identify similarities in and differences between two sets of economic phenomena (F. Beest, G. Braam, S. Boelens 2009, p. 14). If the information can be compared with the financial information presented for other accounting periods, users can identify trends in results and financial position. Information must be presented in a consistent manner between the entities. This will enable users to make important comparisons (H. Greunding, M. Koen 2001, p. 5-6).

Understandability - Information must be easily understood by users of financial statements. People with knowledge of business, economics and accounting should be able to easily understand them. If necessary, footnotes should be used to help understand more complex information s (H. Greunding, M. Koen 2001, p. 5-6). The most important aspects that help in understanding information are: good classification, characterization and clear presentation (P. Scott 2019, p. 11).

Examples of Qualitative characteristics

  • Comparability - Comparability is one of the most important qualitative characteristics of financial information. It is the ability of users to compare financial information across different organizations or between different periods of time. For example, a company can compare its financial performance over time to identify trends and changes in operations.
  • Verifiability - Verifiability is the ability to evaluate the accuracy of financial information through external verification. This includes the use of independent auditors who can verify the accuracy of financial statements. For example, an independent auditor may review the financial statements of a company to ensure accuracy.
  • Understandability - Understandability is the ability of users to interpret financial information without needing to understand complex accounting principles. This includes the use of clear language and logical presentation of financial statements. For example, a company may provide an easy-to-understand explanation of its financial position to potential investors.
  • Relevance - Relevance is the ability of financial information to be useful in making decisions. This includes the use of timely and predictive financial information. For example, a company may use relevant financial information to determine potential future investment opportunities.
  • Reliability - Reliability is the ability of financial information to be free from material misstatements. This includes the use of estimates and assumptions that are based on the best available information. For example, a company may use reliable financial information to make informed decisions about its operations.

Advantages of Qualitative characteristics

Qualitative characteristics of financial information can be beneficial in a variety of ways, including:

  • Increased transparency: By providing accurate and reliable information, users can make better-informed decisions. Qualitative characteristics provide users with a greater understanding of the company’s operations, allowing them to make decisions based on a more complete picture.
  • Improved accuracy: Qualitative characteristics can improve the accuracy of financial statements, reducing the risk of misstating or misrepresenting information. This can help companies avoid potential legal or financial consequences of misstating financial information.
  • Increased comparability: By providing clear and consistent standards, financial statements can be compared across different companies, industries, and countries. This can help users more easily identify trends, such as performance differences between companies.
  • Enhanced credibility: By adhering to established qualitative characteristics, companies can increase their credibility with users, customers, and other stakeholders. This can help build trust and increase investor confidence in the company.

Limitations of Qualitative characteristics

Qualitative characteristics of financial information have limitations, including:

  • They do not provide absolute information but rather an estimation of the financial situation of a company. This presents the risk of inaccurate information or misinterpretation of the data by users.
  • Qualitative characteristics do not guarantee that the information is complete. This can lead to incomplete or unreliable financial statements.
  • Qualitative characteristics are not necessarily applicable to all types of organizations, as each organization may have its own unique characteristics.
  • Qualitative characteristics may not be sufficient to provide a full understanding of the financial situation of a company, and additional analysis may be necessary.
  • Qualitative characteristics do not necessarily take into account the effect of external factors, such as the economy or market conditions, which can have a significant impact on a company's financial situation.

Other approaches related to Qualitative characteristics

  • The Prudence principle - this concept is based on the idea that accounting information should be prepared with a degree of caution and not in a manner that suggests more certainty than is warranted. It is also used to refer to the idea that assets and profits should be stated at their lowest possible value to ensure that the financial statements don't overstate the true financial position of the firm.
  • The Accruals principle - this states that income and expenses should only be recorded when there is a legal obligation or contract between the two parties. This is to ensure that income and expenses are recorded in the same period that the associated economic activity occurred in.
  • The Going Concern principle - this concept states that an entity should continue to operate for the foreseeable future. This concept is used to ensure that assets and liabilities are not overstated or understated in the financial statements.

In conclusion, the use of qualitative characteristics is essential to ensure the accuracy and reliability of financial information. The main qualitative characteristics are the Prudence principle, the Accruals principle, and the Going Concern principle. Each of these characteristics aims to provide users with reliable and useful information that is necessary for making informed decisions.

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Author: Agnieszka Damian