Question # 1
Accounting information refers to the financial data used to gauge an organization’s financial health. Accounting information is analyzed using different documents such as income statements, profit & loss and balance sheets. Given the crucial role of accounting information, it is characterized by the following features: understandability, decision usefulness, relevance, reliability, comparability, and constraints.
The feature of understandability implies that accounting information should be easily understood. Financial statements should be prepared in a manner that it can be efficiently processed and understood by the stakeholders. While the stakeholders have sufficient knowledge of processing business concepts, accounting information should be created in a clear and straightforward manner (Grigoras-Ichim & Morasan-Danila, 2016). The characteristic of understandability also requires financial information to be complete so that the users can make their conclusion.
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The second characteristic is decision usefulness; accounting information should be consistent and enable comparability. Comparability allows users to find the similarities and differences between events. Shareholders are interested in understanding how the organization uses resources; hence, they compare different financial information over the same period to determine whether the organization is utilizing the resources well. Alternatively, consistency involves comparing financial information over different periods to check the company performance over time. Consistency and comparability are two related concepts, and they are useful in decision-making.
The third qualitative feature is relevance; the accounting information should possess either predictive or feedback value or both (Neogy, 2014). The predictive value is utilized in predicting the future, whereas the feedback value is used to confirm prior predictions. Financial information should be useful, and it should be able to influence decision making such that the omission of the information hinders proper decision making by the users.
Alternatively, reliability as a qualitative feature means that the accounting information should be devoid of error and bias. Since the information is used to make critical business decisions, the information should be dependable. The information should be factual by faithfully representing what it purports to be (Neogy, 2014). The feature of reliability is synonymous with credibility, and it is characterized by verifiability, exact representation, and neutrality. Verifiability involves accurately presenting information. Exact representation implies that the information should correctly present the phenomenon it is supposed to while the concept of neutrality means the accounting information should not be biased by favoring specific users.
Lastly, constraints refer to the limitations that have adverse effects on the usefulness of qualitative information. The most significant constraint is the cost of processing the financial information. The cost of providing should not be too expensive in comparison to the benefits of the information. The second constraint is materiality, which implies that the information should be reliable even when it contains immaterial errors.
All the qualitative features are important, but relevance and reliability are the primary features according to the Financial Accounting Standards Board (FASB). Both relevance and reliability are crucial features, but relevance is the most critical feature. When the accounting information is relevant, it is of value to the organization and the stakeholders (Nobes & Stadler, 2014). The information can be used to make better decisions that will help the organization to achieve its goals when it is relevant, making it the essential feature.
Question # 2
The decision usefulness of financial reporting refers to the value of the financial reports. Financial statements are useful sources of information for investors and other stakeholders with vested interests in the firm. According to Dandago & Hassan (2013), the decision usefulness approach is the preparation of financial accounting information with an emphasis on investor decision making. All the information needed by the investor are provided in a manner that it will enable the investor to process the information quickly and make decisions. The concept of decision-usefulness was introduced by the American Accounting Association (AAA) in 1966 as a basic accounting theory (Dandago & Hassan, 2013). AAA concluded that decision usefulness of the financial information is the most important criteria as the information is created with the main purpose of helping users make the best decisions on the way forward.
According to Al Farooque (2016), financial reporting is the communication of financial information with the primary aim of making users make important decisions. Financial reports such as income statements, balance sheets, cash flow statement and equity reports are created with the objective of fulfilling the decision usefulness concepts. Different financial reports have specific purposes, which make it possible for the users to gauge the financial health of the organization.
The standard setters agree that decision usefulness approach is a crucial and practical approach to financial reporting. The decision usefulness approach has created a financial reporting framework whereby financial reports aim to furnish investors, creditors, employees and other interested parties with information on capital allocation decision. The standard setters prefer the decision usefulness approach as it targets capital providers who are crucial shareholders for the firm.
Since the creation of the decision usefulness approach in 1966, it has become the primary approach guiding FASB and IASB standards. In 2007, FASB stated that the primary use of financial reports is to guide investment decision. FASB framework has a strong bias towards investment decisions while neglecting stewardship; thus, FASB is guided by the decision usefulness approach.
FASB framework is almost similar to IASB framework. Cordery & Sinclair (2017) point out that as from 2006 the International Accounting Standards Board (IASB) maintained that decision usefulness is a primary objective for financial reporting whereas stewardship/ accountability is the secondary objective. IASB Conceptual framework states that “The objective of general purpose external financial reporting is to provide information that is useful (emphasis added) to present and potential investors and creditors and others in making investment, credit, and similar resource allocation decisions (IASB, 2008, p. 18).” Despite the amendments to IASB framework aimed to address the limitations of the financial reporting system such as power struggles and lack of accountability, IASB upheld that decision usefulness is the main reason for financial reporting. IASB amended its objectives of financial reporting to give prominence to stewardship because it is favored by European countries, unlike Americans who prefer decision usefulness.
In conclusion, decision usefulness approach remains the most popular approach to financial reporting. The approach has been criticized because it fails to give a comprehensive picture by focusing primarily on the investors. According to Cordery & Sinclair (2017), there is a need for an all-inclusive criterion that treats all users equally while addressing pressing financial issues affecting the firm. Additionally, the accounting boards are yet to agree on the measures to be used using the decision-usefulness approach; hence the firms interpret the approach differently.
References
Al Farooque, O. (2016). Sustainable financial reporting practice in Australian companies-does quality matter? The Journal of Developing Areas , 50 (6), 175-189.
Cordery, C. J., & Sinclair, R. (2016). Decision-Usefulness and Stewardship as Conceptual Framework Objectives: Continuing Challenges. Elsevier. Retrieved from: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2918784
Dandago, K. I., & Hassan, N. I. B. (2013). Decision Usefulness Approach to Financial Reporting: A Case for Malaysian Inland Revenue Board. Asian Economic and Financial Review , 3 (6), 772.
Grigoras-Ichim, C. E., & Morosan-Danila, L. (2016). Hierarchy of Accounting Information Qualitative Characteristics in Financial Reporting. The USV Annals of Economics and Public Administration , 16 (1 (23)), 183-191.
International Accounting Standards Board. 2008. Exposure Draft of an Improved Conceptual Framework for Financial Reporting: Chapter 1 and Chapter 2.
Stadler, C., & Nobes, C. W. (2014). The influence of country, industry, and topic factors on IFRS policy choice. Abacus , 50 (4), 386-421.
