Need for accounting measurement the big 1

Need for accounting measurement
Need for accounting measurement provides a summary of the measurement bases in use in Financial Reporting
and the concepts behind these measurement bases.
The measurement bases that will be considered here are:

All these bases are forms of accrual accounting – that is, they are intended to measure income as it is earned and costs as they are incurred, as opposed to simply recording cash flows. The last four are all forms of current value measurement.

In forming a judgment on the appropriateness of measurement bases, in literature, the overriding tests has been identified to be their cost-effectiveness and fitness for purpose. However, in the absence of direct evidence on these matters, it is usual to argue in terms of various secondary characteristics that ought to be relevant in assessing the quality of information (see the key indicators in What is useful information?).

The most important of these characteristics are generally considered to be relevance and faithful representation / reliability (older term).

For each basis, an outline is given of how it works and the relevance and faithful representation of the resulting measurements. The question of measurement costs is also considered briefly. In reading the analyses that follow, the following comments should be borne in mind.

Bases of measurement in financial reporting are not carved in stone. Different people have different views on how each basis should work, and meanings evolve as practice changes. Some readers may therefore find that the way a particular basis is described does not match how they understand it.

This does not mean either that their understanding is wrong or that the description in the report is wrong; views on these things simply differ.

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Narrative reporting the right way

Narrative reporting

– whether in the form of an Operating and Financial Review (OFR), Management Discussion and Analysis (MD&A), a Business Review or other management commentary – is vital to corporate transparency. Key performance indicators (KPIs), both financial and non-financial, are an important component of the information needed to explain a company’s progress towards its stated goals, for all of these types of narrative reporting.

But despite this fact, KPIs are not well understood. What makes a performance indicator “key”? What type of information should be provided for each indicator? And how can it best be presented to provide effective narrative business reporting?

Setting the stage – two quotes

Although narrative reporting requirements remain fluid, reporting on KPIs is here to stay. I welcome any publication as a valuable contribution to helping companies choose which KPIs to report and what information will provide investors with a real understanding of corporate performance. Using management’s own measures of success really helps deepen investors’ understanding of progress and movement in business. Whether contextual, financial or non-financial, these data points make the trends in the business transparent and help keep management accountable. The illustrations of good practice reporting on KPIs shown here bring alive what is required in a practical and effective way.

KPIs – a critical component

Regulatory environment

The specific requirements for narrative reporting have been a point of debate for several years now. However one certainty remains: the requirement to report financial and non-financial key performance indicators.

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Enhancing qualitative characteristic

Comparability, verifiability, timeliness and understand-ability are qualitative characteristics that enhance the usefulness of information that both is relevant and provides a faithful representation of what it purports to represent. The enhancing qualitative characteristics may also help determine which of two ways should be used to depict a phenomenon if both are considered to provide equally relevant information and an equally faithful representation of that phenomenon.

Faithful representation

Faithful representation - Financial information that faithfully represents the phenomena that it purports to represent, i.e. more than its sheer legal form.

Timeliness

An enhancing qualitative characteristic possessed by information that is available to decision-makers in time to be capable of influencing their decisions. 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.

Understandability

Understandability in accounting information implies clarity. Companies must follow standard accounting principles in order to properly report business transactions. If a company fails to do so, then stakeholders are typically unable to follow the company’s accounting information. Essentially, companies that report financial information in their own specific manner strip away understandability and the ability to understand financial reporting.

Verifiability

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.

Relevance

Relevance - Relevant financial information is capable of making a difference in decisions made by users if it has predictive value, confirmatory value or both.

Obligating event

An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation. A legal obligation is an obligation that derives from: a) a contract (through its explicit or implicit terms); b) legislation; or c) other operation of law. A constructive obligation is an obligation that derives from an entity’s actions where: a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.