Useful Information - Online Tutor, Practice Problems & Exam Prep

Useful information in financial accounting is characterized by relevance and faithful representation. Relevance includes predictive and confirmatory value, while faithful representation encompasses completeness, neutrality, and freedom from material error. The FASB's conceptual framework further emphasizes enhancing qualitative characteristics: comparability, verifiability, timeliness, and understandability. Additionally, four assumptions underpin financial accounting: monetary unit, economic entity, periodicity, and going concern. Measurement principles include historical cost and fair value, alongside the full disclosure principle and cost constraint, ensuring that all significant information is transparently communicated to users.

Fundamental Qualitative Characteristics

Alright. So now we're going to have a bit of an abstract discussion on how information can be useful to the users. Alright. Let's check it out. So for information to be useful to the users, well, it's going to have to have 2 fundamental qualitative characteristics. We call them fundamental qualitative characteristics and these 2 are relevance and faithful representation. Alright. Let's start here with relevance. Relevance is that the information is going to make a difference in the users' decision-making. Okay. So it's actually going to be relevant to their decision. Right? Relevance is going to be relevant to them. So how is it relevant? Well, it's going to have these two characteristics to be relevant. Okay? The first one is it's having predictive value. So what do you think predictive value is going to do? Well, it's going to enable users to predict future outcomes. Right? So that's pretty relevant. If it's information that can help them gauge what's going to happen in the future, that seems pretty relevant. Right? So they're predictive value and guess what confirmatory value is going to do. Well, it's going to help users confirm their previous predictions. Okay? So they might have made a prediction in the past and now they're going to use this information to see if that prediction was true or not. Okay? So that's the relevance. How about faithful representation? Right? Faithful representation, well this is that the information is true. Right? The information has to be true, and to go a little deeper let's talk about these three characteristics here. So faithful representation, we talk about completeness. Alright? Completeness means that the company is providing all relevant information. Right? They're not holding anything back. They're showing everything that should be shown. They're showing it to the users. Next is neutrality. Right? Well, neutrality, that means that the information is unbiased. Right? The company is not taking one side or the other or trying to pad things to make it look better. Right? They're unbiased. They're just showing you information and you do what you will with it. Last is freedom from material error. Alright. Material error. Notice, we're not saying that they can be perfect. Material error means a big error. Okay. Means that there are no, I'll say large errors in the information. Alright. We know no one's perfect and if you think about a company like say Coca Cola or Apple or Amazon that they're they're billion-dollar companies to say that, you know, if they lost a $5 bill here or there, a $100 is missing, it's probably not going to be a huge impact on the users of the information. Right? Because there are so much bigger numbers that they're dealing with that these small errors, they can slide by. Okay. So the freedom from material error. We talked about materiality and that's a threshold for how big an error can be. Okay? And that all depends on the size of the company. You can imagine a small company, maybe a $100 missing could be a big deal, but for a company like Coca Cola, you know, if that gets by, they're going to just not spend the time, figuring out where that went. Okay? So let's pause here and then in the next video, we'll follow-up with the conceptual framework. This is the way the FASB considers information to be useful. They use the conceptual framework to kind of put this all together. Alright? So let's pause here and then continue in the next video.

Enhancing Characteristics

Alright. So here in the center of the screen, we have the FASB's conceptual framework. Alright. So the FASB, they're going to establish their accounting standards based on this conceptual framework, right? So their objective up here, there's all these words providing financial information about the reporting entity. They just want to provide useful information, right? So the objective is to provide useful information, and we already discussed these first two, right? We talked about these fundamental qualitative characteristics, we discussed relevance and faithful representation. Alright? So now let's move on to the rest of this framework where we're going to see the enhancing qualitative characteristics and then the cost constraint, and through these qualitative characteristics, they're going to create their standards based on what information they want to present to the users, right? So let's check it out. Let's move on here to these four enhancing qualitative characteristics, right? Enhancing qualitative characteristics. So let's discuss those right here. Okay?

So the first one here, comparability. Well, what do you think? Comparability. It's in the name right there. Information is comparable. We're able to take the information from one company and compare it to another company. Right? We want the comparison to be consistent. We want that comparability across companies and we want it to be consistent with prior periods. Right? So if we want to compare, let's say, Coca Cola and Pepsi, we want to see their financials, and we want to see, you know, we want to be able to take the information and make judgments based on their information, so we want to be able to compare it, but we also want to look at Coca Cola's statements and be able to look at this year, last year, the previous year, and make decisions based on what's been happening over time, right? So it needs to be consistent over time and comparable across companies for it to be even more useful for users. Okay?

How about verifiability? So guess what? Information can be verified. Right? So notice, all of these terms are just being defined by themselves, right? Information can be verified, and we're verifying it for accuracy, completeness, and reliability, and this is where auditors come in. Alright? So, audit, and this isn't just the IRS; the IRS isn't the only people who do audits, right? Companies themselves hire auditors so that when they give the information to external users, the users feel more comfortable with the information because an auditor has come in and looked at it, right? So, the verifiability, they want to make the information, this is basically where we have a paper trail, right? The verifiability, this is the paper trail where we can make sure that everything you say happened, actually did happen. Okay?

Timeliness. Well, information has to be available in time. This time I didn't fill it in with 'timely,' right? Well, information has to be available in time to make meaningful decisions. You can imagine that you need the information. So if we're going to talk about what happened to Coca Cola in 2017, well if they don't give us that information until 2020, well that's not going to be so timely, right? It's not going to be so useful to us because it's three years late. So that information has to be timely to be even more useful.

And lastly, understandability. The language has to be transparent, okay? So this just basically means that it's not when you read it, you're able to understand it, right? It's not all convoluted, trying to hide information from the users. No. We want to be transparent. We want to tell the users what they want to know, or else why are we even providing this information. Alright? So let's pause here and then let's move on in the next video.

Four Underlying Assumptions

Alright, so on top of that discussion of useful information and its qualitative characteristics, well we're also going to have 4 assumptions in financial accounting that if we didn't assume these things to be true, it would just kind of be silly, okay? So we have 4 underlying assumptions.

All right, let's start here with the first one, the monetary unit assumption. The currency that we're using, whether it's the dollar, the euro, the baht, whatever the currency is, we have to expect it to stay stable, okay? We expect the unit to stay stable; we don't really consider inflation when we make our financial accounting information. We just expect a stable monetary unit.

The next is the economic entity, and this is that the company can be separately identified from other companies or individuals, right? This is the separation of the owners from the business. This is like if you were going to buy a house, you can't just buy a house and say, "Hey, I'm going to put this on the business, don't worry, I'm going to write it off." No, we have to separate the personal lives of the owners from the business or one business from another business; we have to have this sharp boundary between what we're calling the business and what is everything else, alright? So that's the economic entity. Just like here in the example, right? The personal residence of Elon Musk is not included in Tesla's accounting records. Tesla is completely separate from Elon Musk in that sense. Okay?

So let's go on here to the next one, the periodicity assumption, and this is that the economic life of the company can be split up into periods, right? These time periods of reporting, and this basically is for the timeliness effect, right? So we're just going to artificially draw lines, and it's usually going to be at the year mark, right? We're going to break up the company's time into years, right? We're going to say, "Okay, what happened this year? What happened that year?" And it doesn't have to be years, right? We could break it up by month, we could break it up by week. As long as we have these consistent times, it helps with the timeliness of reporting, right? And generally, what we see is that we're going to see quarterly reporting. Every 3 months, there's going to be some information given to investors, and that helps with the timeliness there, right?

And the last one here is the Going Concern assumption. So the assumption of going concern is that the business will operate indefinitely, right? If we didn't assume that the company is just going to stay in business, right? If the assumption is that the business is going to die or if it's just going to run out of money soon, why are we doing all this information anyways, right? So the going concern assumption just assumes that hey, this business is going to keep on going, okay?

So those are our 4 assumptions. Let's pause here, and we'll discuss one more thing in the next video.

Principles of Financial Accounting

Alright guys, I know this discussion has been a bit abstract, but just stick with me, we're almost through it. We're going to discuss the principles of financial accounting in this video. Okay, the principles of financial accounting and there are 2 measurement principles, identified by GAAP. The first one being the historical cost principle and the fair value principle. So this is how we're going to measure something. How do we measure what something is worth? Well, we're either going to use historical cost or fair value, okay?

So historical cost says that companies should record their assets at their cost, right? And assets, we haven't discussed assets yet, but we're going to get into that a little more. Assets are what you own. Assets of the business, that's what you own. So as an example, let's say you purchase land for $50,000. Right? So you're going to record that at $50,000. You're going to have land equal to $50,000. Okay? So when you show your accounting records, you're going to say hey, I have land worth $50,000. Now let's say a year has passed and the land increased in value to $60,000. Well, you're still holding onto that land, you're not going to take that extra $10,000. You're not going to mark it up to 60. Okay? So the historical cost principle says that you're going to leave it at $50,000. Alright? So the land will stay at $50,000 and that can make sense. Right? Because the value of the land can go up and down, so this keeps stability. Right? Historical cost aims at stability, being able to just say hey, this land is at $50,000 when we sell the land or when we transfer the land, that's when we'll deal with the change in the value. But for now, let's just keep it stable. It's $50,000. Okay?

Compare that to the fair value principle. Okay? So this says that the company should report at their current market value. So that same example, well, I guess now I change the example to say Apple stock because this is how we would use it in real terms here. So, in this example, we're going to purchase $50,000 worth of Apple stock. So, we're going to have Apple stock equal to $50,000 right? We're going to have $50,000 worth of it and when we show our financial information, we're going to say, hey, we have $50,000 of Apple stock. Right? But now let's say that after a year, the value of Apple stock went up to $60,000. Right? Same as in the land example. Well, in this case, when we're using the fair value principle, we're going to show that Apple stock on our books. Whoops. Apple stock. We're going to show it as $60,000. Alright? Because that's the fair market value. Okay? And we're going to see that different types of assets are going to follow the historical cost principle or fair value principle. And it can make sense that the land would follow the historical cost principle because this might be something that you buy, you're going to put a building on it, you're going to use it for a long time. Right? You're just going to have it sitting there, so there's no reason to be marking up the land and say, hey, we're making money on this land when you're just still going to have it sitting there, right? Compare that to a fair value principle for something like stock. Well, stock might just be a short-term investment that the company is making and they want to know what that's going to be valued at, right, and it's very simple to find the value of Apple stock, right? You just got to Google, type in Apple, and you've got the stock price right there, alright? So it's very easy to keep a fair value and you can see there's benefits to both of these. Historical cost has the benefit of stability, right? We're able to keep a stable price on this where the fair value principle gives us more relevant to this moment information, right? So there's give and take in both situations. Alright?

So those are our measurement principles. Let's talk about the full disclosure principle. What full disclosure, this kind of goes with completeness, right? A company must disclose all events that would impact user's information. So this goes with that completeness requirement, right? Remember we talked about completeness of information when we were when we had faithful representation? So this full disclosure principle, it just requires that you disclose everything and this might go past just numbers, right? We might have actual written words to tell the users, hey, this is a little more information about this subject. Okay? Now with the full disclosure principle, of course, we can't tell them everything. Alright? Sometimes there's going to be this cost constraint where some information might just be too costly to gather. Alright? We have to weigh the benefits against the cost, like how much is this going to help the user's information versus how much is it going to cost us to actually find out what this information is. Okay? So there is that cost constraint. If something's way too costly to come up with that information, then it might not be worth it. Alright? So those are the principles there. Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What are the fundamental qualitative characteristics of useful financial information?

The fundamental qualitative characteristics of useful financial information are relevance and faithful representation. Relevance means the information can influence users' decisions, having predictive value (helping to forecast future outcomes) and confirmatory value (confirming past predictions). Faithful representation ensures the information is complete (all necessary information is provided), neutral (unbiased), and free from material error (no significant errors that could mislead users).

How does the FASB's conceptual framework enhance the usefulness of financial information?

The FASB's conceptual framework enhances the usefulness of financial information through four enhancing qualitative characteristics: comparability (information can be compared across companies and time periods), verifiability (information can be checked for accuracy and reliability), timeliness (information is available in time to influence decisions), and understandability (information is presented clearly and transparently).

What are the four assumptions in financial accounting?

The four assumptions in financial accounting are: 1) Monetary Unit Assumption: assumes the currency used remains stable over time. 2) Economic Entity Assumption: separates the business's financial information from the owners' personal information. 3) Periodicity Assumption: divides the economic life of a business into artificial time periods for reporting purposes. 4) Going Concern Assumption: assumes the business will continue to operate indefinitely.

What is the difference between historical cost and fair value measurement principles?

The historical cost principle records assets at their original purchase price, providing stability over time. For example, land bought for $50,000 remains recorded at that value, regardless of market changes. The fair value principle, on the other hand, records assets at their current market value. For instance, if $50,000 worth of Apple stock increases to $60,000, it is recorded at the new market value, reflecting more current and relevant information.

What is the full disclosure principle in financial accounting?

The full disclosure principle requires companies to disclose all information that could impact users' decisions. This includes not only numerical data but also written explanations of significant events. However, this principle is balanced by a cost constraint, meaning that if the cost of obtaining certain information outweighs its benefits, it may not be disclosed.