The conceptual framework of accounting enumerates four principal qualitative characteristics that serve as both guide and basis in the preparation of financial statements. These qualitative characteristics include relevance, reliability, understandability and comparability.
These four qualitative characteristics relate to the content and the presentation of quantitative financial accounting information. By applying the concept of these qualitative characteristics in good faith, the effectiveness and usefulness of financial information is ensured. Thus, satisfying the diverse needs of both external and internal data users.
The term relevance simply means that useful information should have the capacity to make a difference in the decision making process of entrepreneurs and managers. It should help data users in predicting the outcome of different business undertakings.
Relevance, on the other hand, is affected by its nature and materiality. A non-material transaction cannot influence a business decision thus it isn't relevant.
In addition, relevance requires that financial accounting information should be pertinent to economic decisions. In order to achieve relevance, financial information should have the ingredients of predictive value, feedback value and timeliness.
Reliability refers to the degree of confidence data users put on the faithfulness and truthfulness of the financial accounting information.
Reliability is an attribute of financial information making it neutral, free from bias and error and complete. The concept of prudence or conservatism also has a direct impact upon the reliability of the financial information.
Under conservatism, when options exist, the option which has the least effect on equity should be chosen. Likewise, transactions should also be recorded in accordance of their economic substance and not merely on their legal form.
The third qualitative characteristic, understandability requires that financial accounting information must facilitate understanding. Moreover, it should be intelligible and comprehensible to the point that it can be flexible and be understood by not just business executives and stockholders but as well as the general public.
It should be presented and expressed in business languages that all data users understand.
However, complex business activities make it impossible to reduce the preparation and presentation of financial statements in simplest terms, thus, the conceptual framework assumes that data users have a reasonable knowledge of business and accountancy.
Comparability simply means the ability to compare, to bring together financial accounting information for the purpose of noting similarities, difference and to monitor the growth of the business entity.
It should be comparable horizontally and dimensionally meaning it should be comparable within the entity and across entities.
Comparability is necessary to identify current trends in the market, the growth of the company, the performance, benchmarking and to make accurate predictions about future transactions.