Other characteristics of accounting
Accounting is often called the language of business. The Accounting process is geared to communicate the results of business operations and status to different stakeholders of an entity. Accounting reports are needed by various groups such as shareholders, lenders, potential investors, financial newspaper columnists, owners, and others. Given the usefulness of accounting reports to these interested parties, the language of such communication must be generally understood by all.
Moreover, Accounting information is not just reports and numbers. It’s the tool that supports decision-making. Accounting information is used by different people in various settings with specific purposes in mind. For instance, investors may be interested in the profitability of a company and its ability to generate cash flow, whereas managers present cash flow statements to bankers for getting them to extend credit or for preparing payslips for employees.
Users of accounting
Potential users of accounting information include:
- Business owners. They have the first right over the information of the business, how profitable their investment is, and what financial worth it have?
- A potential Investor. If some want to purchase or invest in a business, obviously they want to know the financial health and performance of the business.
- Mangers. They are responsible for the performance of the respective sections of the business, so they need financial results to access how effectively they are managing their business and identify the area where there is a need for further improvement.
- The bank. If the bank has already lent or the business is seeking any bank loan, the bank will look into the financial performance and position of the company.
- Regulatory Authorities (e.g. Tax inspector). They need an accounting and financial information to ascertain that the entity has complied with the regulatory requirements. · There are many other users of accounting information. For example, Debtors and employees. It is a well-known fact that a business can have many different types of stakeholders that require different forms of information to take various decisions thus making it impossible to produce accounting information in a form that is appropriate for many different groups of stakeholders. As a result, generally, accounting focuses on presenting information for owners.
Characteristics of Accounting
Ultimately, the real users of accounting information are decision-makers who have a wide range of characteristics that determine the usefulness of financial information that they receive from others.
Below are the characteristics any accounting information shall have to be useful to decision-makers.
Relevance
Information is relevant if it can make a difference in decisions already made or in decisions that are going to be made. In other words, information is relevant if it is capable of adding value. The relevance of financial information is enhanced if it has the following characteristics-
- Predictive- In that, it enables decision-makers to forecast future cash flows and thereby avoid bad investments and make good investment proposals. It provides a basis for forecasting future market conditions and thereby helps in deciding the most appropriate strategy for business development.
- Confirmatory- In that, it validates the forecasts of other management decision tools such as marketing plans, production plans, pricing policies and financial plans.
Faithful representation
We can say that accounting information is faithful if it is represented in a way that reflects the real situation. Example: The books of accounts of “XYZ Ltd” show sales amounting to $20,000. The sales were only $10,000. In this case, the information is not a faithful representation. Because of this unfaithful presentation of facts, the company may take some wrong decisions like inventory control or production planning.
The accounting information should be complete & free from errors: This means that there should be no missing or incorrect figures while recording the transactions. It will help in avoiding errors while taking decisions. For Example, the balance sheet of XYZ Ltd as of 31st March shows the cash balance as $1,000 whereas, in reality, it was $2,000. As a result, the wrong decision may be taken relating to dividend payment and borrowing facilities.
Accounting information shall reflect the facts: This means that the accounting information should give a true & fair view of the financial position of the organization. Accounting information is prepared for different purposes like production planning, profit estimation, and resource allocation among others. Therefore, they must reflect all those facts which are required for those purposes only and no other purpose.
Understandability
Financial Information is inherently complex, so to make it easier to understand, prepared information shall be clear, concise, and readily understandable. This can be accomplished by using clear titles, sufficient headings, tables, graphs illustrations, etc
Clear Information should be appropriate to the needs of the users. Information should not contain any hidden meanings or messages. It should also not contain any irrelevant information. Information should also be consistent in reporting. Every time a user looks at the same document, he/she should get the same meaning out of it. This can only happen if there is uniformity in the presentation and application of concepts used in the preparation of information.
Concise: Information should be limited to the relevant facts. To make more complex financial statements more understandable, accountants often use lengthy sentences and paragraphs. But this does not help in making them more understandable or user-friendly to investors or others who may look for information contained in such reports. Information shall also not be redundant or repetitive. When necessary, efforts must be made to eliminate unnecessary repetition from financial statements so that they are easier to read and understand.
Comparability
Comparability is a characteristic in which the information provided by an entity is consistent with that provided by another entity. For example, when comparing the financial statements of two or more companies, the accounting methods and policies used must be similar for the comparisons to be meaningful. If one company reports inventory using LIFO and another company uses FIFO, a comparison of any inventory information will be meaningless because the two methods are not comparable.
In other words, two entities’ accounting policies must be aligned before their accounting statements can be compared. Note that comparability does not require identical accounting policies and methods; it does require that any differences between entities be disclosed to allow users to determine which method better represents reality for each entity.
Comparability of accounting information is essential for making meaningful comparisons. For example, it would be meaningless to compare profits of two different years without a common basis to do it. Comparability can be achieved and maintained through a variety of means such as uniformity in accounting standards, and uniformity in accounting practices and procedures.
Information should be comparable over time and between entities. A company’s financial statements are useful only when they can be compared to those of other companies and over time. Without this, a company’s performance cannot be measured and it is impossible to assess whether the company is performing well. In other words, the numbers have to mean something. Since the information presented by a company is subject to interpretation, reporting standards must be developed to make the information comparable from one company to another. A reporting standard ensures that the information presented conforms with generally accepted accounting principles and is useful for comparing one company with another, enabling investors to make better-informed decisions about allocating their investments.
Verifiability
Accounting information is produced by keeping records of transactions and events that occur in the business. The accounting system ensures that the financial statements conform to the recognized accounting principles. The following are characteristics of accounting information. If information cannot be verified, it casts doubts on its faithful representation causing dubious decisions. The information shall be verifiable up to the extent that knowledgeable and independent third parties can reach a consensus.
Timeliness
Accounting information must be timely to be useful. If the information is not available when needed, it will not be used. The greater the time lag between the occurrence of an event and its financial reporting, the less useful it is to current management decisions or investors in making investment decisions
