There is no point in creating financial statements if they are not useful to readers. Financial statements should therefore abide by a common set of general principles: information demonstrates certain characteristics and readers can also assume certain things about this information. In this article, we review these assumptions and characteristics. When we are preparing financial statements or solving a financial problem for a client, it is good practice to check and ensure that none of the assumptions or characteristics are being violated.
Underlying Assumptions:
Readers of financial statements can assume two general principles. These two principles form the basis of what are called the "Underlying Assumptions" of financial reporting. The two assumptions are listed below.
Accrual Basis: Revenues and expenses are recognized when they are incurred and not necessarily when cash is received.
Going Concern: It is assumed that the company shall continue to operate for the foreseeable future and is not preparing for sale/liquidation or bankruptcy.
Characteristics:
In addition to the basic assumptions, reporting frameworks will also have a list of characteristics that form the basis for their financial statements.
IFRS:
Under the IFRS reporting framework (i.e.: reporting for public companies), statements are prepared using a set of qualitative and enhancing characteristics.
Qualitative Characteristics of financial statements include:
Relevance: The accounting information provided is useful to stakeholders. The information may influence their decision making.
Faithful Representation: The information accurately reflects the financial state of the business. Three attributes of Faithful Representation include:
- Completeness: Relevant information is not omitted.
- Neutrality: Information is presented in a manner that is unbiased.
- Freedom from Material Error: Information does not have any errors large enough to affect the decisions of the stakeholders.
Enhancing Characteristics of financial statements include:
Comparability: Accounting policies are kept consistent from year to year, and information is presented in a manner that makes it easy for users to compare year-on-year info.
Understandability: Information should be presented in a way such that users with reasonable knowledge of accounting should be able to understand what we are presenting.
Verifiability: Information can be verified by other independent users to produce the same results.
Timeliness: Information should be reported in a timely manner, so that it remains relevant.
ASPE:
Under the ASPE reporting framework (i.e.: Canadian reporting standards for private companies), statements are prepared using a similar set of characteristics, listed below.
Understandability: Information should be presented in a way such that users with reasonable knowledge of accounting should be able to understand what we are presenting.
Relevance: The accounting information provided is useful to stakeholders and has the following characteristics:
- Predictive value
- Timeliness
Reliability: The information provided has the following characteristics:
- Faithful Representation
- Verifiability
- Neutrality
- Conservatism
Comparability: Accounting policies are kept consistent from year to year, and information is presented in a manner that makes it easy for users to compare year-on-year info.
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