Question

Accounting systems generally produce information about numbers - certainly necessary for both decision-making and control. However, other information is also needed in both decision-making and control. Discuss the non-quantitative information that could prove useful to management, indicating the types of decisions and/or control issues where it would prove helpful.

Answer 1

The basic objective of financial reporting is to provide information that is useful in making business and economic decisions. What makes accounting information useful for decision-making? The answer is however the accounting information confirms to the qualities that should be possessed by the financial reporting. The ICAI in its The Framework for the Preparation and Presentation of Financial Statements has given the following main qualitative characteristics of Financial Statements. 1. Understandability 2. Relevance 3. Reliability 4. Comparability The characteristics better defined as qualities that should be possessed by financial reports in order that they meet the needs of the users could be classified into user specific qualities and primary decision specific qualities. User Specific Qualities. (a) Decision Makers and their Characteristics. The information requirement of users varies from user to user. So a fine balance should be kept in disclosing too much information or too little information. Similarly disclosure of certain information to those who are already in possession of such information makes little relevance to them. If the receiver of the same could not understand certain information, it makes little contribution to the purpose at hand. (b) Understandability. The information provided through financial reports may be of not much use unless the receivers are willing to study and use it. Financial reports should provide information understandable to all and should contain all relevant information required. Understandability of information is governed by user characteristics and characteristics of information provided. Understandability may be relating to particular decisions makers (like understanding of the language in which the report is made or relating to classes of decision makers (like intelligence to understand the information provided). Primary Decision Specific Qualities. (a) Relevance. The information provided should be logically related to the decision to be made in order that it is relevant. Information is relevant if it can make a difference to the decision taken on knowing it. In order that the information provided through financial reports to be relevant to the various users like shareholders, creditors and others in making investment and credit decisions, such information should be capable of making difference in the prediction about the outcome of past, present and future events or to confirm or correct expectations. The information, which is relevant for one decision, may not be relevant for another decision-making. If particular information is not relevant to a certain decision, then it will be unable to influence the decision either way. Relevant information reduces the uncertainty surrounding the predictions made by the decision-maker. The information itself may not be prediction but when it has predictive value it goes as an input into the prediction process. The quality of relevance has two components namely, feedback value and predictive value. Feedback value is the quality of the information to confirm the outcome of the predictions made in the past. Predictive value means value as input into a predictive process, not value directly as a prediction. Feedback value and predictive value goes hand in hand. Future is a continuation of the past. The same information, which gives a feedback on past activities, will help in predicting the future. Segment Reporting and Interim Earning Reports are examples of information, which helps in giving feedback about the past activities of the organization and also helps in making predictions about the future earnings capacity. Financial models made on the basis-disclosed information will help in predicting the future performance of the enterprise. Timeliness is an ancillary aspect of relevance. The information should be made available when it is required. Otherwise it will be irrelevant to the decision to be made. Similarly if the information is reported a long time after it's happening it may lose the quality of relevance. Timeliness means making available the information to the user before it loses its capacity to influence decisions. But timeliness doesn't make irrelevant information relevant but lack of it could convert relevant information to be irrelevant. Timeliness could not be put in a timeframe like a day or week. It depends on the nature of the information and the decision to which it is to be applied. A fine balance should be maintained between timeliness and precision. Imprecise information of a certain degree may be more useful if provided in time than precise information provided untimely b) Reliability Reliability is the quality which assures to the user of the data that ,it represents what it purports to represent .The ICAI Framework states in paragraphs 31 and 32 as follows To be useful information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. Information may be relevant but in nature or representation that its recognition may be potentially misleading. For example, if the validity and amount of a claim for damages under a legal action against the enterprise are highly uncertain, it may be inappropriate for the enterprise to recognize the amount of the claim in the balance sheet, although it may be appropriate to disclose the amount and circumstances of the claim. Accounting information is reliable so far as the reported information represents the true economic condition of the business, which it is supposed to present. Reliability of accounting information arises from the two qualities of representational faithfulness, verifiability and neutrality. Representational faithfulness is the agreement of the description of the phenomenon with the actual phenomenon. In financial statements the state of affairs or the economic condition of the entity is supposed to be represented. Representational faithfulness is satisfied when the financial statements represent the actual state of affairs of the entity with greater degree of precision .It does not mean cent percent accuracy of the figures as stated. Estimations, apportionment and human judgments are always involved in accounting, which may be arbitrary, or cost considerations may come in the way of attaining cent percent accuracy of the figures in the financial statements. The quality of verifiability is to provide a significant degree of assurance that accounting measures represent what they purport to represent. The quality of verification helps to reduce measurer bias. It assures that the reported information represents what it purports to represent. Verification does not assume that the information provided is relevant as input to the decision to be made. Verifiability avoids both measurer bias and measurement bias. Measurer bias could be avoided by repeated measurement using the same measurement techniques .APB in its statement no.4 has stated, " Verifiable financial accounting information provides results that would be substantially duplicated by independent measures using the same measurement methods. Measurement methods should also be avoided in the financial information. The method of measurement should represent what it purports to represent. Neutrality is the quality that information presented should be objective or unbiased, in that it should meet all proper user needs. The provider of the information should not be biased towards the needs of any one-user group. The reports should be neutral between the competing needs of various user groups. Neutrality implies that in the formulation of accounting standards, the relevance of the information to the users should be the primary consideration than its impact on the interest of a particular user group(s). The objectives of financial reporting should be to provide information to the general-purpose users of such information. Hence accounting facts and practices should be impartially determined with out any bias. Neutrality is lost when a particular result is desired and information is provided to attain that result. Paragraph 36 of the ICAI Framework reads as To be reliable, the information contained in financial statements must be neutral, that is, free from bias. Financial statements are not neutral if, by the selection or presentation of information, they influence the making of a decision or judgment in order to achieve a predetermined result or outcome. (C) Comparability The receivers of accounting information use the same for taking economic decisions. Decisions involve selecting the best available alternative. The best alternative could be selected only when a comparative study is possible amongst all the available alternatives. Financial statements should have the quality of comparability. Comparison may be done with information about other enterprises or with information about the same enterprise over a period of time. Quantitative information is useful only when it could be compared with some benchmark. Comparison helps to detect and explain similarities and differences in the data compared. Paragraph 39 of the ICAI Framework reads Users must be able to compare the financial statements of an enterprise through time in order to identify trends in its financial performance and cash flows. Users must also be able to compare the financial statements of different enterprises in order to evaluate their relative financial position, performance and cash flows. Hence, the measurement and display of the financial effects of like transactions and other events must be carried out in a consistent throughout an enterprise and over time for that enterprise and in a consistent way for different enterprises. The quality of comparability could be attained only when there is consistency in the accounting methods, adopted in the reporting of financial information. Consistency in the principles and methods used in accounting will enhance the utility of financial statements to users by facilitating analysis and understanding of comparative accounting data. The Accounting Principles Board stated in APB Opinion No.20, Accounting changes that " in the preparation of financial statements there is a presumption that as accounting principle once adopted should not be changed in accounting for events and transactions of similar type. Consistent use of accounting principles from one period to another enhances the utility of financial statement to users by facilitating analysis and understanding of comparative accounting data." Consistency may mean use of the same accounting procedure by an entity from period to period or use of same procedures and methods for related items in a single statement or the use of the same methods and procedures by different entities. Even though consistency is essential to maintain comparability of reported accounting information but too much adherence to the same will act as deterrent to bringing about desirable changes in accounting and thus hinder the progress of accounting.