Respond to the following questions in a clear and concise way that demonstrates critical thinking and rational arguments to support your conclusions: What is the purpose of the conceptual

Conceptual Framework for Financial Reporting

Chapter 3, Qualitative Characteristics of Useful Financial Information

Statement of Financial Accounting Concepts No. 8

As Amended

August 2018

a replacement of FASB Concepts Statements No. 1 and No. 2

Copyright © 2018 by Financial Accounting Foundation. All rights reserved. Content copyrighted by Financial Accounting Foundation may not be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Financial Accounting Foundation.

Conceptual Framework for Financial Reporting

Chapter 3, Qualitative Characteristics of Useful Financial Information

Statement of Financial Accounting Concepts No. 8

As Amended

August 2018

Financial Accounting Standards Board 401 MERRITT 7, PO BOX 5116, NORWALK, CONNECTICUT 06856-5116

a replacement of FASB Concepts Statements No. 1 and No. 2

Statement of Financial Accounting Concepts No. 8

As Amended

Conceptual Framework for Financial Reporting

August 2018

CONTENTS

Paragraph Numbers

Chapter 3: Qualitative Characteristics of Useful Financial Information …………………………………………………………………………….. QC1–QC39 Introduction …………………………………………………………………………. QC1–QC3 Qualitative Characteristics of Useful Financial Information ……….. QC4–QC34 Fundamental Qualitative Characteristics………………………….. QC5–QC18 Relevance …………………………………………………………….. QC6–QC11 Materiality ………………………………………………….. QC11–QC11B Faithful Representation …………………………………………. QC12–QC16 Applying the Fundamental Qualitative Characteristics …………………………………………………… QC17–QC18 Enhancing Qualitative Characteristics …………………………… QC19–QC34 Comparability ………………………………………………………. QC20–QC25 Verifiability ………………………………………………………….. QC26–QC28 Timeliness …………………………………………………………………….. QC29 Understandability …………………………………………………. QC30–QC32 Applying the Enhancing Qualitative Characteristics …… QC33–QC34 The Cost Constraint on Useful Financial Reporting ……………….. QC35–QC39 Appendix: Basis for Conclusions for Chapter 3 …………………………. BC3.1–BC3.48 Introduction …………………………………………………………………….. BC3.1–BC3.3 Background …………………………………………………………………………. BC3.3 The Objective of Financial Reporting and the Qualitative Characteristics of Useful Financial Information …………………… BC3.4–BC3.7 Fundamental and Enhancing Qualitative Characteristics ……… BC3.8–BC3.43 Fundamental Qualitative Characteristics……………………. BC3.11–BC3.31 Relevance ………………………………………………………. BC3.11–BC3.18 Predictive and Confirmatory Value ………………. BC3.14–BC3.15 The Difference between Predictive Value and Related Statistical Terms ………………………………………. BC3.16

Paragraph Numbers Materiality ……………………………………………… BC3.17–BC3.18D Faithful Representation …………………………………….. BC3.19–BC3.31 Replacement of the Term Reliability …………….. BC3.20–BC3.25 Substance over Form …………………………………………….. BC3.26 Prudence (Conservatism) and Neutrality ………. BC3.27–BC3.29 Can Faithful Representation Be Empirically Measured? ……………………………………………… BC3.30–BC3.31 Enhancing Qualitative Characteristics ………………………. BC3.32–BC3.43 Comparability ………………………………………………….. BC3.32–BC3.33 Verifiability ……………………………………………………… BC3.34–BC3.36 Timeliness ………………………………………………………. BC3.37–BC3.39 Understandability …………………………………………….. BC3.40–BC3.43 Qualitative Characteristics Not Included ………………………….. BC3.44–BC3.46 The Cost Constraint on Useful Financial Reporting………….. BC3.47–BC3.48

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Statement of Financial Accounting Concepts No. 8 As Amended

Conceptual Framework for Financial Reporting

CHAPTER 3: QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION

Introduction

QC1. The qualitative characteristics of useful financial information discussed in this chapter identify the types of information that are likely to be most useful to the existing and potential investors, lenders, and other creditors for making decisions about the reporting entity on the basis of information in its financial report (financial information).

QC2. Financial reports provide information about the reporting entity’s economic resources, claims against the reporting entity, and the effects of transactions and other events and conditions that change those resources and claims. (This information is referred to in the Conceptual Framework as information about the economic phenomena.) Some financial reports also include explanatory material about management’s expectations and strategies for the reporting entity and other types of forward-looking information.

QC3. The qualitative characteristics of useful financial information1 apply to financial information provided in financial statements, as well as to financial information provided in other ways. Cost, which is a pervasive constraint on the reporting entity’s ability to provide useful financial information, applies similarly. However, the considerations in applying the qualitative characteristics and the cost constraint may be different for different types of information. For example, applying them to forward-looking information may be different from applying them to information about existing economic resources and claims and to changes in those resources and claims.

1Throughout this Conceptual Framework, the terms qualitative characteristics and constraint refer to the qualitative characteristics of, and the constraint on, useful financial information.

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Qualitative Characteristics of Useful Financial Information

QC4. If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely, and understandable.

Fundamental Qualitative Characteristics QC5. The fundamental qualitative characteristics are relevance and faithful representation.

Relevance

QC6. Relevant financial information is capable of making a difference in the decisions made by users. Information may be capable of making a difference in a decision even if some users choose not to take advantage of it or already are aware of it from other sources.

QC7. Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value, or both.

QC8. Financial information has predictive value if it can be used as an input to processes employed by users to predict future outcomes. Financial information need not be a prediction or forecast to have predictive value. Financial information with predictive value is employed by users in making their own predictions.

QC9. Financial information has confirmatory value if it provides feedback (confirms or changes) about previous evaluations.

QC10. The predictive value and confirmatory value of financial information are interrelated. Information that has predictive value often also has confirmatory value. For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, also can be compared with revenue predictions for the current year that were made in past years. The results of those comparisons can help a user to correct and improve the processes that were used to make those previous predictions.

Materiality

QC11. Relevance and materiality are defined by what influences or makes a difference to an investor or other decision maker; however, the two concepts can be distinguished from each other. Relevance is a general notion about what type of information is useful to investors. Materiality is entity specific. The omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable that the

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judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.

QC11A. A decision not to disclose certain information or recognize an economic phenomenon may be made, for example, because the amounts involved are too small to make a difference to an investor or other decision maker (they are immaterial). However, magnitude by itself, without regard to the nature of the item and the circumstances in which the judgment has to be made, generally is not a sufficient basis for a materiality judgment.

QC11B. No general standards of materiality could be formulated to take into account all the considerations that enter into judgments made by an experienced, reasonable provider of financial information. That is because materiality judgments can properly be made only by those that understand the reporting entity’s pertinent facts and circumstances. Whenever an authoritative body imposes materiality rules or standards, it is substituting generalized collective judgments for specific individual judgments, and there is no reason to suppose that the collective judgments always are superior.

Faithful Representation

QC12. Financial reports represent economic phenomena in words and numbers. To be useful, financial information not only must represent relevant phenomena, but it also must faithfully represent the phenomena that it purports to represent. To be a perfectly faithful representation, a depiction would have three characteristics. It would be complete, neutral, and free from error. Of course, perfection is seldom, if ever, achievable. The Board’s objective is to maximize those qualities to the extent possible.

QC13. A complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations. For example, a complete depiction of a group of assets would include, at a minimum, a description of the nature of the assets in the group, a numerical depiction of all of the assets in the group, and a description of what the numerical depiction represents (for example, original cost, adjusted cost, or fair value). For some items, a complete depiction also may entail explanations of significant facts about the quality and nature of the items, factors and circumstances that might affect their quality and nature, and the process used to determine the numerical depiction.

QC14. A neutral depiction is without bias in the selection or presentation of financial information. A neutral depiction is not slanted, weighted, emphasized, deemphasized, or otherwise manipulated to increase the probability that financial information will be received favorably or unfavorably by users. Neutral information does not mean information with no purpose or no influence on behavior. On the contrary, relevant financial information is, by definition, capable of making a difference in users’ decisions.

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QC15. Faithful representation does not mean accurate in all respects. Free from error means there are no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process. In this context, free from error does not mean perfectly accurate in all respects. For example, an estimate of an unobservable price or value cannot be determined to be accurate or inaccurate. However, a representation of that estimate can be faithful if the amount is described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate.

QC16. A faithful representation, by itself, does not necessarily result in useful information. For example, a reporting entity may receive property, plant, and equipment through a government grant. Obviously, reporting that an entity acquired an asset at no cost would faithfully represent its cost, but that information probably would not be very useful. A slightly more subtle example is an estimate of the amount by which an asset’s carrying amount should be adjusted to reflect an impairment in the asset’s value. That estimate can be a faithful representation if the reporting entity has applied properly an appropriate process, described properly the estimate, and explained any uncertainties that significantly affect the estimate. However, if the level of uncertainty in such an estimate is sufficiently large, that estimate will not be particularly useful. In other words, the relevance of the asset being faithfully represented is questionable. If there is no alternative representation that is more faithful, that estimate may provide the best available information.

Applying the Fundamental Qualitative Characteristics

QC17. Information must be both relevant and faithfully represented if it is to be useful. Neither a faithful representation of an irrelevant phenomenon, nor an unfaithful representation of a relevant phenomenon, helps users make good decisions.

QC18. The most efficient and effective process for applying the fundamental qualitative characteristics usually would be as follows (subject to the effects of enhancing characteristics and the cost constraint, which are not considered in this example). First, identify an economic phenomenon that has the potential to be useful to users of the reporting entity’s financial information. Second, identify the type of information about that phenomenon that would be most relevant if it is available and can be faithfully represented. Third, determine whether that information is available and can be faithfully represented. If so, the process of satisfying the fundamental qualitative characteristics ends at that point. If not, the process is repeated with the next most relevant type of information.

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Enhancing Qualitative Characteristics QC19. Comparability, verifiability, timeliness, and understandability are qualitative characteristics that enhance the usefulness of information that is relevant and faithfully represented. The enhancing qualitative characteristics also may help determine which of two ways should be used to depict a phenomenon if both are considered equally relevant and faithfully represented.

Comparability

QC20. Users’ decisions involve choosing between alternatives, for example, selling or holding an investment, or investing in one reporting entity or another. Consequently, information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date.

QC21. Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items. Unlike the other qualitative characteristics, comparability does not relate to a single item. A comparison requires at least two items.

QC22. Consistency, although related to comparability, is not the same. Consistency refers to the use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities. Comparability is the goal; consistency helps to achieve that goal.

QC23. Comparability is not uniformity. For information to be comparable, like things must look alike and different things must look different. Comparability of financial information is not enhanced by making unlike things look alike any more than it is enhanced by making like things look different.

QC24. Some degree of comparability is likely to be attained by satisfying the fundamental qualitative characteristics. A faithful representation of a relevant economic phenomenon should naturally possess some degree of comparability with a faithful representation of a similar relevant economic phenomenon by another reporting entity.

QC25. Although a single economic phenomenon can be faithfully represented in multiple ways, permitting alternative accounting methods for the same economic phenomenon diminishes comparability.

Verifiability

QC26. 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

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representation. Quantified information need not be a single point estimate to be verifiable. A range of possible amounts and the related probabilities also can be verified.

QC27. Verification can be direct or indirect. Direct verification means verifying an amount or other representation through direct observation, for example, by counting cash. Indirect verification means checking the inputs to a model, formula, or other technique and recalculating the outputs using the same methodology. An example is verifying the carrying amount of inventory by checking the inputs (quantities and costs) and recalculating the ending inventory using the same cost flow assumption (for example, using the first-in, first-out method).

QC28. It may not be possible to verify some explanations and forward-looking financial information until a future period, if at all. To help users decide whether they want to use that information, it normally would be necessary to disclose the underlying assumptions, the methods of compiling the information, and other factors and circumstances that support the information.

Timeliness

QC29. 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

QC30. Classifying, characterizing, and presenting information clearly and concisely makes it understandable.

QC31. 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 potentially misleading.

QC32. Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyze 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.

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Applying the Enhancing Qualitative Characteristics

QC33. Enhancing qualitative characteristics should be maximized to the extent possible. However, the enhancing qualitative characteristics, either individually or as a group, cannot make information useful if that information is irrelevant or not faithfully represented.

QC34. Applying the enhancing qualitative characteristics is an iterative process that does not follow a prescribed order. Sometimes, one enhancing qualitative characteristic may have to be diminished to maximize another qualitative characteristic. For example, a temporary reduction in comparability as a result of prospectively applying a new financial reporting standard may be worthwhile to improve relevance or faithful representation in the longer term. Appropriate disclosures may partially compensate for noncomparability.

The Cost Constraint on Useful Financial Reporting

QC35. Cost is a pervasive constraint on the information that can be provided by financial reporting. Reporting financial information imposes costs, and it is important that those costs are justified by the benefits of reporting that information. There are several types of costs and benefits to consider.

QC36. Providers of financial information expend most of the effort involved in collecting, processing, verifying, and disseminating financial information, but users ultimately bear those costs in the form of reduced returns. Users of financial information also incur costs of analyzing and interpreting the information provided. If needed information is not provided, users incur additional costs to obtain that information elsewhere or to estimate it.

QC37. Reporting financial information that is relevant and faithfully represents what it purports to represent helps users to make decisions with more confidence. This results in more efficient functioning of capital markets and a lower cost of capital for the economy as a whole. An individual investor, lender, and other creditor also receive benefits by making more informed decisions. However, it is not possible for general purpose financial reports to provide all the information that every user finds relevant.

QC38. In applying the cost constraint, the Board assesses whether the benefits of reporting particular information are likely to justify the costs incurred to provide and use that information. When applying the cost constraint in developing a proposed financial reporting standard, the Board seeks information from providers of financial information, users, auditors, academics, and others about the expected nature and quantity of the benefits and costs of that standard. In most situations, assessments are based on a combination of quantitative and qualitative information.

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QC39. Because of the inherent subjectivity, different individuals’ assessments of the costs and benefits of reporting particular items of financial information will vary. Therefore, the Board seeks to consider costs and benefits in relation to financial reporting generally, and not just in relation to individual reporting entities. That does not mean that assessments of costs and benefits always justify the same reporting requirements for all entities. Differences may be appropriate because of different sizes of entities, different ways of raising capital (publicly or privately), different users’ needs, or other factors.

This Concepts Statement was adopted by the unanimous vote of the five members of the Financial Accounting Standards Board:

Robert H. Herz, Chairman Thomas J. Linsmeier Leslie F. Seidman Marc A. Siegel Lawrence W. Smith

The amendments in this Concepts Statement were adopted by the unanimous vote of the seven members of the Financial Accounting Standards Board:

Russell G. Golden, Chairman James L. Kroeker, Vice Chairman Christine A. Botosan Marsha L. Hunt Harold L. Monk, Jr. R. Harold Schroeder Marc A. Siegel

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APPENDIX: BASIS FOR CONCLUSIONS FOR CHAPTER 3

Introduction

BC3.1 This basis for conclusions summarizes considerations of the Board in reaching the conclusions in Chapter 3, Qualitative Characteristics of Useful Financial Information. It includes reasons for accepting some alternatives and rejecting others. Individual Board members gave greater weight to some factors than to others.

BC3.2 The Board developed this chapter jointly with the International Accounting Standards Board (IASB). Consequently, this basis for conclusions also includes some references to the IASB’s literature.

Background BC3.3 The Board began the process of developing the qualitative characteristics of useful financial information by reviewing its own framework and concepts as well as those of other standard setters. In July 2006, the Board published for public comment a Discussion Paper on this topic. That same paper also was published by the IASB. The Board and the IASB received 179 responses. In its redeliberations of the issues on this topic, the Board considered all of the comments received and information gained from other outreach initiatives. In May 2008, the Board and the IASB jointly published an Exposure Draft. The Boards received 142 responses. The Board reconsidered all of the issues. This document is the result of those reconsiderations.

The Objective of Financial Reporting and the Qualitative Characteristics of Useful Financial Information

BC3.4 Alternatives are available for all aspects of financial reporting, including recognition, derecognition, measurement, classification, presentation, and disclosure. When developing financial reporting standards, the Board will choose the alternative that goes furthest towards achieving the objective of financial reporting. Providers of financial information also will have to choose among the alternatives if there are no applicable standards available, or if application of a particular standard requires judgments or options, to achieve the objective of financial reporting.

BC3.5 Chapter 1 specifies that the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. The decision makers on which this

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Conceptual Framework focuses are existing and potential investors, lenders, and other creditors.

BC3.6 That objective by itself leaves a great deal to judgment and provides little guidance on how to exercise that judgment. This chapter describes the first step in making the judgments needed to apply that objective. It identifies and describes the qualitative characteristics that financial information should have if it is to meet the objective of financial reporting. It also discusses cost, which is a pervasive constraint on financial reporting.

BC3.7 Subsequent chapters will use the qualitative characteristics to help guide choices about recognition, measurement, and the other aspects of financial reporting.

Fundamental and Enhancing Qualitative Characteristics

BC3.8 This chapter distinguishes between the fundamental qualitative characteristics that are the most critical, and the enhancing qualitative characteristics that are less critical but still highly desirable. The Discussion Paper did not explicitly distinguish between those qualitative characteristics. The Board made the distinction later because of confusion among respondents to the Discussion Paper about how the qualitative characteristics relate to each other.

BC3.9 Some respondents to the Exposure Draft stated that all of the qualitative characteristics should be considered equal and that the distinction between fundamental and enhancing qualitative characteristics was arbitrary. Others said that the most important qualitative characteristic differs depending on the circumstances; therefore, differentiating among the qualitative characteristics was not appropriate.

BC3.10 The Board does not agree that the distinction is arbitrary. Financial information without the two fundamental qualitative characteristics of relevance and faithful representation is not useful, and it cannot be made useful by being more comparable, verifiable, timely, or understandable. However, financial information that is relevant and faithfully represented may still be useful even if it does not have any of the enhanc

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