Appendix: Objective and qualitative characteristics (Framework_07-04_COMPmar20_07-21)

The objective of general purpose financial reporting forms the foundation of the Framework.  Other aspects of the Framework—a reporting entity concept, the qualitative characteristics of, and the constraint on, useful financial information, elements of financial statements, recognition, measurement, presentation and disclosure—flow logically from the objective.

The objective of general purpose financial reporting ^[1]is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.  Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.  

Among the users of financial information about a not-for-profit reporting entity are existing and potential resource providers (such as investors, lenders and other creditors, donors and taxpayers), recipients of goods and services (such as beneficiaries, for example, members of the community) and parties performing a review or oversight function on behalf of other users (such as advisers and members of parliament).  Such users may make resource allocation decisions in relation to not-for-profit entities that differ from those identified in paragraph OB2.  For example, parliaments decide, on behalf of constituents, whether to fund particular programmes for delivery by an entity, taxpayers decide who should represent them in government, donors decide whether to donate resources to an entity, and recipients decide whether they can continue to rely on the provision of goods and services from the entity or whether to seek alternative suppliers.  In relation to not-for-profit entities, where pertinent, all references in this Framework to ‘existing and potential investors, lenders and other creditors’ (and related terms) should be read as a reference to this broader range of users.

Decisions by existing and potential investors about buying, selling or holding equity and debt instruments depend on the returns that they expect from an investment in those instruments, for example dividends, principal and interest payments or market price increases.  Similarly, decisions by existing and potential lenders and other creditors about providing or settling loans and other forms of credit depend on the principal and interest payments or other returns that they expect.  Investors’, lenders’ and other creditors’ expectations about returns depend on their assessment of the amount, timing and uncertainty of (the prospects for) future net cash inflows to the entity.  Consequently, existing and potential investors, lenders and other creditors need information to help them assess the prospects for future net cash inflows to an entity.

In respect of not-for-profit entities, users (such as certain existing and potential resource providers) are generally not concerned with obtaining a financial return on an investment in the entity.  Rather, they are concerned with the ability of the entity to achieve its objectives (whether financial or non-financial), which in turn may depend, at least in part, on the entity’s prospects for future net cash inflows.  Users will, for example, be interested in the capability of the entity’s resources to provide goods and services in the future.  Accordingly, in relation to not-for-profit entities, where pertinent, references in this Framework to ‘assessing prospects for future net cash inflows’ (and related terms) should be read in the context of the common information needs of users of general purpose financial reports of not-for-profit entities described in this paragraph.

To assess an entity’s prospects for future net cash inflows, existing and potential investors, lenders and other creditors need information about the resources of the entity, claims against the entity, and how efficiently and effectively the entity’s management and governing board^[2] have discharged their responsibilities to use the entity’s resources.  Examples of such responsibilities include protecting the entity’s resources from unfavourable effects of economic factors such as price and technological changes and ensuring that the entity complies with applicable laws, regulations and contractual provisions.  Information about management’s discharge of its responsibilities is also useful for decisions by existing investors, lenders and other creditors who have the right to vote on or otherwise influence management’s actions.

Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the financial information they need.  Consequently, they are the primary users to whom general purpose financial reports are directed.

However, general purpose financial reports do not and cannot provide all of the information that existing and potential investors, lenders and other creditors need.  Those users need to consider pertinent information from other sources, for example, general economic conditions and expectations, political events and political climate, and industry and company outlooks.

General purpose financial reports are not designed to show the value of a reporting entity; but they provide information to help existing and potential investors, lenders and other creditors to estimate the value of the reporting entity.

Individual primary users have different, and possibly conflicting, information needs and desires.  The Board, in developing financial reporting standards, will seek to provide the information set that will meet the needs of the maximum number of primary users.  However, focusing on common information needs does not prevent the reporting entity from including additional information that is most useful to a particular subset of primary users.

The management of a reporting entity is also interested in financial information about the entity.  However, management need not rely on general purpose financial reports because it is able to obtain the financial information it needs internally.

Other parties, such as regulators and members of the public other than investors, lenders and other creditors, may also find general purpose financial reports useful.  However, those reports are not primarily directed to these other groups.^[3] 

To a large extent, financial reports are based on estimates, judgements and models rather than exact depictions.  The Framework establishes the concepts that underlie those estimates, judgements and models.  The concepts are the goal towards which the Board and preparers of financial reports strive.  As with most goals, the Framework’s vision of ideal financial reporting is unlikely to be achieved in full, at least not in the short term, because it takes time to understand, accept and implement new ways of analysing transactions and other events.  Nevertheless, establishing a goal towards which to strive is essential if financial reporting is to evolve so as to improve its usefulness.

General purpose financial reports provide information about the financial position of a reporting entity, which is information about the entity’s economic resources and the claims against the reporting entity.  Financial reports also provide information about the effects of transactions and other events that change a reporting entity’s economic resources and claims.  Both types of information provide useful input for decisions about providing resources to an entity.

Information about the nature and amounts of a reporting entity’s economic resources and claims can help users to identify the reporting entity’s financial strengths and weaknesses.  That information can help users to assess the reporting entity’s liquidity and solvency, its needs for additional financing and how successful it is likely to be in obtaining that financing.  Information about priorities and payment requirements of existing claims helps users to predict how future cash flows will be distributed among those with a claim against the reporting entity.

Different types of economic resources affect a user’s assessment of the reporting entity’s prospects for future cash flows differently.  Some future cash flows result directly from existing economic resources, such as accounts receivable.  Other cash flows result from using several resources in combination to produce and market goods or services to customers.  Although those cash flows cannot be identified with individual economic resources (or claims), users of financial reports need to know the nature and amount of the resources available for use in a reporting entity’s operations.

Changes in a reporting entity’s economic resources and claims result from that entity’s financial performance (see paragraphs OB17–OB20) and from other events or transactions such as issuing debt or equity instruments (see paragraph OB21).  To properly assess the prospects for future cash flows from the reporting entity, users need to be able to distinguish between both of these changes.

Information about a reporting entity’s financial performance helps users to understand the return that the entity has produced on its economic resources.  Information about the return the entity has produced provides an indication of how well management has discharged its responsibilities to make efficient and effective use of the reporting entity’s resources.  Information about the variability and components of that return is also important, especially in assessing the uncertainty of future cash flows.  Information about a reporting entity’s past financial performance and how its management discharged its responsibilities is usually helpful in predicting the entity’s future returns on its economic resources.

Accrual accounting depicts the effects of transactions and other events and circumstances on a reporting entity’s economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period.  This is important because information about a reporting entity’s economic resources and claims and changes in its economic resources and claims during a period provides a better basis for assessing the entity’s past and future performance than information solely about cash receipts and payments during that period. 

Information about a reporting entity’s financial performance during a period, reflected by changes in its economic resources and claims other than by obtaining additional resources directly from investors and creditors (see paragraph OB21), is useful in assessing the entity’s past and future ability to generate net cash inflows.  That information indicates the extent to which the reporting entity has increased its available economic resources, and thus its capacity for generating net cash inflows through its operations rather than by obtaining additional resources directly from investors and creditors.

In respect of not-for-profit entities, information useful for assessing an entity’s past and future ability to generate net cash inflows through its operations is, in turn, useful for assessing whether income from taxpayers, donors and other sources was sufficient, and is likely to remain sufficient, to meet the cost of a given volume and quality of goods and services the entity provides.

Information about a reporting entity’s financial performance during a period may also indicate the extent to which events such as changes in market prices or interest rates have increased or decreased the entity’s economic resources and claims, thereby affecting the entity’s ability to generate net cash inflows.

Information about a reporting entity’s cash flows during a period also helps users to assess the entity’s ability to generate future net cash inflows.  It indicates how the reporting entity obtains and spends cash, including information about its borrowing and repayment of debt, cash dividends or other cash distributions to investors, and other factors that may affect the entity’s liquidity or solvency.  Information about cash flows helps users understand a reporting entity’s operations, evaluate its financing and investing activities, assess its liquidity or solvency and interpret other information about financial performance.

A reporting entity’s economic resources and claims may also change for reasons other than financial performance, such as issuing additional ownership shares.  Information about this type of change is necessary to give users a complete understanding of why the reporting entity’s economic resources and claims changed and the implications of those changes for its future financial performance.

The qualitative characteristics of useful financial information discussed in this chapter identify the types of information that are likely to be most useful to the existing and potential investors, lenders and other creditors for making decisions about the reporting entity on the basis of information in its financial report (financial information).

Financial reports provide information about the reporting entity’s economic resources, claims against the reporting entity and the effects of transactions and other events and conditions that change those resources and claims.  (This information is referred to in the Framework as information about the economic phenomena.)  Some financial reports also include explanatory material about management’s expectations and strategies for the reporting entity, and other types of forward-looking information.

The qualitative characteristics of useful financial information^[4]apply to financial information provided in financial statements, as well as to financial information provided in other ways.  Cost, which is a pervasive constraint on the reporting entity’s ability to provide useful financial information, applies similarly.  However, the considerations in applying the qualitative characteristics and the cost constraint may be different for different types of information.  For example, applying them to forward-looking information may be different from applying them to information about existing economic resources and claims and to changes in those resources and claims.

If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent.  The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.

The fundamental qualitative characteristics are relevance and faithful representation.

Relevant financial information is capable of making a difference in the decisions made by users.  Information may be capable of making a difference in a decision even if some users choose not to take advantage of it or are already aware of it from other sources.

Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value or both.

Financial information has predictive value if it can be used as an input to processes employed by users to predict future outcomes.  Financial information need not be a prediction or forecast to have predictive value.  Financial information with predictive value is employed by users in making their own predictions.

Financial information has confirmatory value if it provides feedback about (confirms or changes) previous evaluations.

The predictive value and confirmatory value of financial information are interrelated.  Information that has predictive value often also has confirmatory value.  For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, can also be compared with revenue predictions for the current year that were made in past years.  The results of those comparisons can help a user to correct and improve the processes that were used to make those previous predictions.

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial reports (see paragraph OB5) make on the basis of those reports, which provide financial information about a specific reporting entity.  In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entity’s financial report.  Consequently, the Board cannot specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation.

Financial reports represent economic phenomena in words and numbers.  To be useful, financial information must not only represent relevant phenomena, but it must also faithfully represent the phenomena that it purports to represent.  To be a perfectly faithful representation, a depiction would have three characteristics.  It would be complete, neutral and free from error.  Of course, perfection is seldom, if ever, achievable.  The Board’s objective is to maximise those qualities to the extent possible.

A complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations.  For example, a complete depiction of a group of assets would include, at a minimum, a description of the nature of the assets in the group, a numerical depiction of all of the assets in the group, and a description of what the numerical depiction represents (for example, original cost, adjusted cost or fair value).  For some items, a complete depiction may also entail explanations of significant facts about the quality and nature of the items, factors and circumstances that might affect their quality and nature, and the process used to determine the numerical depiction.

A neutral depiction is without bias in the selection or presentation of financial information.  A neutral depiction is not slanted, weighted, emphasised, de-emphasised or otherwise manipulated to increase the probability that financial information will be received favourably or unfavourably by users.  Neutral information does not mean information with no purpose or no influence on behaviour.  On the contrary, relevant financial information is, by definition, capable of making a difference in users’ decisions.

Faithful representation does not mean accurate in all respects.  Free from error means there are no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process.  In this context, free from error does not mean perfectly accurate in all respects.  For example, an estimate of an unobservable price or value cannot be determined to be accurate or inaccurate.  However, a representation of that estimate can be faithful if the amount is described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate.

A faithful representation, by itself, does not necessarily result in useful information.  For example, a reporting entity may receive property, plant and equipment through a government grant.  Obviously, reporting that an entity acquired an asset at no cost would faithfully represent its cost, but that information would probably not be very useful.  A slightly more subtle example is an estimate of the amount by which an asset’s carrying amount should be adjusted to reflect an impairment in the asset’s value.  That estimate can be a faithful representation if the reporting entity has properly applied an appropriate process, properly described the estimate and explained any uncertainties that significantly affect the estimate.  However, if the level of uncertainty in such an estimate is sufficiently large, that estimate will not be particularly useful.  In other words, the relevance of the asset being faithfully represented is questionable.  If there is no alternative representation that is more faithful, that estimate may provide the best available information.

Information must be both relevant and faithfully represented if it is to be useful.  Neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of a relevant phenomenon helps users make good decisions.

The most efficient and effective process for applying the fundamental qualitative characteristics would usually be as follows (subject to the effects of enhancing characteristics and the cost constraint, which are not considered in this example).  First, identify an economic phenomenon that has the potential to be useful to users of the reporting entity’s financial information.  Second, identify the type of information about that phenomenon that would be most relevant if it is available and can be faithfully represented.  Third, determine whether that information is available and can be faithfully represented.  If so, the process of satisfying the fundamental qualitative characteristics ends at that point.  If not, the process is repeated with the next most relevant type of information.

Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the usefulness of information that is relevant and faithfully represented.  The enhancing qualitative characteristics may also help determine which of two ways should be used to depict a phenomenon if both are considered equally relevant and faithfully represented.

Users’ decisions involve choosing between alternatives, for example, selling or holding an investment, or investing in one reporting entity or another.  Consequently, information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date.

Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items.  Unlike the other qualitative characteristics, comparability does not relate to a single item.  A comparison requires at least two items.

Consistency, although related to comparability, is not the same.  Consistency refers to the use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities.  Comparability is the goal; consistency helps to achieve that goal.

Comparability is not uniformity.  For information to be comparable, like things must look alike and different things must look different.  Comparability of financial information is not enhanced by making unlike things look alike any more than it is enhanced by making like things look different.

Some degree of comparability is likely to be attained by satisfying the fundamental qualitative characteristics.  A faithful representation of a relevant economic phenomenon should naturally possess some degree of comparability with a faithful representation of a similar relevant economic phenomenon by another reporting entity.

Although a single economic phenomenon can be faithfully represented in multiple ways, permitting alternative accounting methods for the same economic phenomenon diminishes comparability.

Verifiability helps assure users that information faithfully represents the economic phenomena it purports to represent.  Verifiability means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.  Quantified information need not be a single point estimate to be verifiable.  A range of possible amounts and the related probabilities can also be verified.

Verification can be direct or indirect.  Direct verification means verifying an amount or other representation through direct observation, for example, by counting cash.  Indirect verification means checking the inputs to a model, formula or other technique and recalculating the outputs using the same methodology.  An example is verifying the carrying amount of inventory by checking the inputs (quantities and costs) and recalculating the ending inventory using the same cost flow assumption (for example, using the first-in, first-out method).

It may not be possible to verify some explanations and forward-looking financial information until a future period, if at all.  To help users decide whether they want to use that information, it would normally be necessary to disclose the underlying assumptions, the methods of compiling the information and other factors and circumstances that support the information.

Timeliness means having information available to decision-makers in time to be capable of influencing their decisions.  Generally, the older the information is the less useful it is.  However, some information may continue to be timely long after the end of a reporting period because, for example, some users may need to identify and assess trends.

Classifying, characterising and presenting information clearly and concisely makes it understandable.

Some phenomena are inherently complex and cannot be made easy to understand.  Excluding information about those phenomena from financial reports might make the information in those financial reports easier to understand.  However, those reports would be incomplete and therefore potentially misleading.

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently.  At times, even well-informed and diligent users may need to seek the aid of an adviser to understand information about complex economic phenomena.

Enhancing qualitative characteristics should be maximised to the extent possible.  However, the enhancing qualitative characteristics, either individually or as a group, cannot make information useful if that information is irrelevant or not faithfully represented.

Applying the enhancing qualitative characteristics is an iterative process that does not follow a prescribed order.  Sometimes, one enhancing qualitative characteristic may have to be diminished to maximise another qualitative characteristic.  For example, a temporary reduction in comparability as a result of prospectively applying a new financial reporting standard may be worthwhile to improve relevance or faithful representation in the longer term.  Appropriate disclosures may partially compensate for non-comparability.

Cost is a pervasive constraint on the information that can be provided by financial reporting.  Reporting financial information imposes costs, and it is important that those costs are justified by the benefits of reporting that information.  There are several types of costs and benefits to consider.

Providers of financial information expend most of the effort involved in collecting, processing, verifying and disseminating financial information, but users ultimately bear those costs in the form of reduced returns.  Users of financial information also incur costs of analysing and interpreting the information provided.  If needed information is not provided, users incur additional costs to obtain that information elsewhere or to estimate it.

Reporting financial information that is relevant and faithfully represents what it purports to represent helps users to make decisions with more confidence.  This results in more efficient functioning of capital markets and a lower cost of capital for the economy as a whole.  An individual investor, lender or other creditor also receives benefits by making more informed decisions.  However, it is not possible for general purpose financial reports to provide all the information that every user finds relevant.

In applying the cost constraint, the Board assesses whether the benefits of reporting particular information are likely to justify the costs incurred to provide and use that information.  When applying the cost constraint in developing a proposed financial reporting standard, the Board seeks information from providers of financial information, users, auditors, academics and others about the expected nature and quantity of the benefits and costs of that standard.  In most situations, assessments are based on a combination of quantitative and qualitative information.

Because of the inherent subjectivity, different individuals’ assessments of the costs and benefits of reporting particular items of financial information will vary.  Therefore, the Board seeks to consider costs and benefits in relation to financial reporting generally, and not just in relation to individual reporting entities.  That does not mean that assessments of costs and benefits always justify the same reporting requirements for all entities.  Differences may be appropriate because of different sizes of entities, different ways of raising capital (publicly or privately), different users’ needs or other factors.