The Importance of Understandability in Accounting

Accounting information has several attributes. One of these attributes is understandability. This attribute is in addition to the other common ones found in accounting data, such as relevance, consistency, comparability and reliability. Stakeholders rely on these attributes in order to review and comprehend accounting information released by a company each period.

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.

Comparability is a secondary aspect of understandability. Its importance comes from the review of two different companies’ financial information placed next to each other. Stakeholders can then understand each company’s information and make assertions based on the data in the reports. Without understandability, comparability reduces, even to the point of its absence. Stakeholders who cannot make decisions based on financial data lose benefits gained from this information.

A reasonable amount of financial acumen is often an inherent assumption with understandability. The concept does not imply a business must make its data understandable for all individuals, regardless of business knowledge. Accountants should make every attempt to provide information that regular business individuals can understand. For example, disclosures on accounting policies can help increase understandability among stakeholders.