Understandability – An enhancing qualitative characteristic possessed by financial information that is classified, characterized and presented clearly and concisely.
The Conceptual Framework provides the following guidance [Conceptual Framework 2.34 – 2.36]:
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 possibly 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.
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.
When companies follow standard accounting principles, understandability increases among stakeholders. This also leads to consistency in financial reporting. Consistency means a company handles its business transactions the same way each time they occur. When a company comes to rely on these attributes, then reasonable expectations begin. For example, stakeholders believe they can predict how a company will perform financially based on previous financial information.
A principle of accounting which states that a company’s financial information should be presented in such a way that a person with a reasonable knowledge of business and finance, and the willingness to study the information, should be able to comprehend it.
Understandability requires the information presented in financial reports to be concise, complete and clear in presentation. The information should be presented so as to facilitate the user of the information.
However, understandability never prescribes any complex information to be omitted altogether due to its underlying difficulty in understanding. It just requires us to disclose the information systematically instead of presenting it haphazardly.
It is assumed that users possess a reasonable knowledge of business, economic activities and accounting and that they are willing to study information with reasonable diligence. However, information about complex matters that should be included in the financial statements because of its relevance to the economic decision-making needs of users should not be excluded merely on the grounds that such information may be too complex for certain users to understand (IASB 2009a:82).
In an effort to enhance understandability, D’Souza (2008) notes that fair value measure eliminate the hundreds of rules underlying historical cost accounting. D’Souza (2008) further argues that, in order to remove control of the reported numbers from corporate management, it should be required that the reported numbers for assets and liabilities be reported on a fair value basis. The revenues, expenses, gains and losses are accounting constructs and, thus, the starting point of eliminating manipulations must be assets and liabilities and the statement of comprehensive income should then reflect the movement of these assets and liabilities.
Prospective financial information
There has been increasing demand in recent years for more disclosure of prospective financial information (PFI). Although PFI disclosures are invariably regarded as being relevant to investors, there are also good reasons why they are not made on a regular and comprehensive basis by all companies. Doubts often surround the accuracy, reliability and understandability of such financial information.
Information is material if its omission or misrepresentation could reasonably be expected to influence the economic decisions shareholders take on the basis of the annual report as a whole. Only information that is material in the context of the strategic report should be included within it.
Conversely, the inclusion of immaterial information can obscure key messages and impair the understandability of information provided in the strategic report. Immaterial information should be considered for exclusion from financial statements.
Duplication of information
The duplication of information should generally be avoided as it usually leads to unnecessary volumes of disclosure detracting from the understandability and usefulness of the annual report as a whole. This can be achieved by using signposting or cross-referencing. In some cases, it may be necessary to repeat certain pieces of information, although this should be limited to circumstances when this would tell the company’s story more effectively.
The directors might consider some information on trends and factors to be relevant to an understanding of an entity’s strategy, principal risks and current year performance.
The directors might choose to highlight relevant linkages either through:
- combining relevant information on trends and factors with the strategy, principal risks and current year performance disclosures;
- highlighting linkages between relevant information on trends and factors and different parts of the strategic report dealing with strategy, principal risks and current year performance; or
- a combination of some or all of the above.
See also: Conceptual Framework 2018
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