QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

The FASB states that relevance and reliability are the two primary qualities that make
accounting information useful for decision making. As the FASB sees it, a hierarchy of qualities
exists. This can be summarized as follows:
Usefulness of information for decision making:
1. Relevance
a. Predictive value
b. Feedback value
c. Timeflies
2. Reliability
a. Verifiability
b. Neutrality
c. Representational faithfulness
3. Secondary qualities are comparability and consistency which interact with relevance and
reliability.
4. Costs and benefits and materiality are constraints on the usefulness of information.
RELEVANCE
To be relevant, information must be logically related to a given decision. The FASB points out
that to be relevant to investors, creditors, and others for investment, credit, and similar decisions,
accounting information must be capable of making a difference in a decision by helping users to
form predictions about the outcomes of past, present, and future events or to confirm or correct
expectations. Information is relevant to a decision if it can reduce the uncertainty about the
variables in the decision process. Timeliness is also a component of relevance. If the information
is not available at the time a decision needs to be made, it lacks relevance.
MATERIALITY
The FASB considers materiality to be a constraint on both relevance and reliability, although it
admits that the former has much in common with materiality. Materiality is primarily related to
relevance. If an item is not material, then is not relevant.
Materiality Guides by Authoritative Bodies
The SEC states that if an amount is not material, it need not be separately set forth. It defines
materiality in terms of the information that an average prudent investor ought reasonably to be

informed. Occasionally, it has provided specific quantitative guidelines. It requires disclosure of

the following:

The APB in Statement No. 4 mentioned that financial reporting is only concerned with
significant information. It found it necessary to establish specific quantitative criteria
for given information. Materiality should be considered in determining the cumulative
effect of a change in principle (Opinion 20), and in determining that an item is

extraordinary (Opinion 30)

The FASB in Concepts Statement No. 2 defines materiality as follows:
The magnitude of an omission or misstatement of accounting information that, in the
light of surrounding circumstances, makes it probable that the judgment of a reasonable
person relying on the information would have been changed or influenced by the

omission or misstatement.
The FASB has given quantitative guidelines for a number of situations.

Authoritative bodies have considered these distinctions to be sufficiently significant to

necessitate the use of specific quantitative guides.
Judicial Decisions
The Judge concluded that the preceding items were material or not depends on evidence.
Empirical Studies
A number of empirical studies have been conducted on materiality. They can classified as those
that focus on the preparer or auditor of the financial statements, and those that concentrate on the
user of the statements.
General Quantitative Criteria
The FASB expresses the opinion that no general standards of materiality could be formulated to
take into account all the considerations that enter into an experienced human judgment.
Individual judgments are required to assess materiality, or to decide what the appropriate
minimum quantitative criteria are for given situations.
RELIABILITY

The FASB states that the reliability of a measure has to do with how faithful the measure
represents what it purports to represents. In general usage, reliability can be viewed :
1. To say that a measure is reliable is to say that it can be depended on to do the job for
which it is used.
It implies effectiveness, but in accounting we prefer to call this quality relevance. It is the
second meaning that the FASB prefers for the term reliability. As mentioned earlier, the
FASB sees reliability as consisting of three components: representational faithfulness,
verifiability, and neutrality. Representational faithfulness, the most critical element of
reliability, concerns the correspondence between a measure or description and the economic
object or event it purports to represent.
2. A measure is reliable if it is a correct quantitative description of the actual condition,
object, or event it represents.

OBJECTIVITY
Objectivity as a Criterion in Accounting
Paton and Littleton remarked that one of the significant contributions made by professional
auditing in its early years of development was the emphasis placed upon objective evidence.
They further stated that verifiable, objective evidence has become an important element in
accounting and a necessary adjunct to the proper execution of the accounting function of
supplying dependable information. Authoritative bodies have also recognized the importance of
objectivity.
Meaning of Objectivity
The differentiation between object and subject is emphasized. The idea is based on the
philosophy that objective truth is something that is external to the human mind (the subject). To
contrast objectivity with subjectivity can be misleading, if by the latter is meant the utilization of
human thought processes. Rather, the contrast should be with a narrower view of subjectivity,
namely, introspectively. This refers to something that is purely personal and hidden from public
scrutiny. Likewise, it is also misleading to contrast objectivity with professional judgment, if by

the latter is mean the forming of conclusions based on training and experience. When perception
and judgment are accepted as inevitable, objectivity is interpreted by some as a certain state of
mind of the observer or investigator. In fact, the meaningfulness of a criterion of objectivity is
based on the acceptance of the existence of these influences.
Suggested Control Devices
From an operational point of view, we see objectivity as pertaining to the establishment of
specific control devices to help accountants minimize inaccuracies in the observationmeasurement process. The control devices have to do with making public or external what is
essentially introspective; with eliminating personal biases as much as possible; and with
obtaining general agreement of these control devices. To some extent, rules under the headings
of disclosure, consistency, comparability, and materiality, as well as generally accepted
accounting principles, are practical control devices reflecting the desire for objectivity. In the
accounting literature, the practical control devices offered under the caption of objectivity have
taken three forms:
1. To make specific and precise the concepts and procedures of accounting and to obtain
general agreement on them.
2. To determine a consensus of the measure among a number of experts.
3. To improve the standards of competence and ethics of the profession.
Objectivity Applied in Practice
Objectivity alone does not lead to useful information. However, there are practical reasons why
we may emphasize the evaluation of accounting data for their objectivity:
1. If by empirical evidence a procedure has been found to furnish relevant information, then
thereafter one need only to examine data for their objectivity.
2. If by logical argument a certain procedure has been judged to provide relevant results,
need only to be determined objective.
3. In many cases, to discern whether a procedure truly provides relevant information is
difficult; therefore, relying on good judgment of users to select data for themselves, we
can at least determine that the data are objective.
CONSERVATISM

Conservatism is not mentioned by the FASB as an element of useful information, but it is too
pervasive a convention to be ignored. The APB recognized its influence and listed conservatism
as a modifying convention of financial accounting in Statement No. 4. It explained that assets
and liabilities are often valued in a context of significant uncertainties, and accountants have
therefore responded by taking a conservative stance.
Historical Background
Chatfield traces the convention of conservatism to the Middle Ages, when the lord of the manor
left the running of his estate to a steward. In late-nineteenth-century England, Chatfield points
out that auditors were often named as descendants in lawsuits brought by investors after the
bankruptcy of a company. In the United States, bankers were the most influential users of
accounting information, and they wanted a conservative approach. Certainly the experience of
the 1920s and the ensuing crash solidified the desire for conservatism.
Criticisms of Conservatism
Through the years, the convention of conservatism has been criticized by many accountants. A
summary of the criticisms follows:
1. Inconsistency
When an asset is understated, it will cause an overstatement of income when the asset is
used or sold.
2. Capriciousness
The extent of conservatism in the financial statements is a matter of policy by the firm. It
may be great or small.
3. Concealment
Although it is generally known that accounting methods are conservative, it is difficult
for investors to determine the amount of the understatement of assets.
4. Contradiction of accounting principles
Sterling indicates that whenever conservatism clashes with an accounting principle, it
prevails over the principle.
5. Bias
Conservatism causes a systematic bias in the financial reports rather than a realistic
assessment. Because of this, as the FASB points out, conservatism tends to conflict with
significant qualitative characteristics, such as representational faithfulness, neutrality, and
comparability (including consistency).
6. State of mind

Conservatism is so entrenched in accounting that it has become more an attitude, a state

of mind, of accountants than simply a mechanism used in response to uncertainty.
Defense of Conservatism
Despite the criticisms, advocates maintain that conservatism continues to be followed in practice
because years of experience have demonstrated to accountants that it is a prudent, useful
convention in an environment filled with uncertainty.
Position of FASB on Conservatism
The FASB asserts that conservatism should no longer connote deliberate, consistent
understatement of net assets and profits. Conservatism should no longer require deferring
recognition of income beyond the time that adequate evidence of its existence becomes available.
Although the FASB does not favor the employment of conservative practices where the effect is
the conscious understatement of net assets and income, the fact is that such practices are part of
generally accepted accounting principles.
TESTING FOR RELIABILITY
The notion of reliability advanced by the FASB is comparable to that in educational psychology.
The FASB speaks of representational faithfulness, neutrality and verifiability, which indicates
that the focus is on errors or bias. Both psychologists and accountants show that they are mainly
concerned with the dependability of the results, which implies that the results are within an
acceptable range of error. Psychologists have developed procedures to test for reliability by
utilizing statistical means.
Theory of Reliability
The reliability of measurement refers to the precision (lack of unsystematic variation) with which
some property is measured by specified operations (instrument); it is the extent to which our
measurements do not contain random fluctuations or unexplainable factors.
We can view every value derived from a given operation as the sum of a normal component
and an unsystematic error component. That is,
X =N +e

Keterangan:

X = derived value
N = normal value
e = unsystematic error component

A formal definition of reliability is that it is the proportion of normal variance in derived value.
Reliability, r, can be expressed as follows:
r=

Variance of N
Variance of X

or

r=1

Variance of e
Variance of X

Estimating Reliability
On a practical level, reliability relates to the stability and consistency of judgments in the
employment of a given set of operations. We would like to know whether:
1. A given individual would express the same judgment (opinion) about the same object or
event at different points of time (assuming time is not a crucial factor).
2. A given group of individuals would each express the same judgment (opinion) about the
same object or event at a given time.
TESTING FOR RELEVANCE
As mentioned earlier, the FASB believes that relevance of accounting information for decision
making by users relates to the characteristics of predictive value, feedback value, and timeliness.
Sterling believes that the relevance of accounting measures pertains to whether the given
attribute being measured is specified by the decision model employed. Whichever way we view
relevance, persuasive evidence must be forwarded to suggest conclusions about the relevance of
accounting measures for given types of decisions. The FASB makes reference to studies and
procedures in educational psychology regarding the concept of validity.
Construct Validity
A construct is an abstract variable that is put together (constructed) by an investigator or those in
a given field of study, such as intelligence, anxiety, financial condition, profitability, liquidity, or
risk. The construct then is seen as the theory that implies certain theorems about observable

relations that are to be tested empirically. Construct validity directs us to discover the
implications of the abstract variable regarding observable behavior.
Content Validity
This is a weak procedure for ascertaining validity, but it is acceptable if seen simply as one of
three approaches rather than the only one. Presently, in accounting practice, this appears to be the
way we determine the validity, that is, the relevance, of our measurement operations.
Predictive Validity
The third ant most effective approach to the question of validity is called predictive validity. This
is an empirical procedure where attention is focused on whether a measurement operations is
valid in furnishing results that can be used to predict a certain form of behavior. Studies on the
predictive value of accounting information are based on the notion of predictive validity.