The primary objective of accounting is to provide financial information that's useful to stakeholders, such as current investors, potential investors, lenders and creditors. The Financial Accounting Standards Board -- FASB for short -- maintains and continually updates a set of qualitative characteristics that help accountants decide what information to provide and how to present it.
Fundamental and Enhancing Qualitative Characteristics
The two fundamental qualitative characteristics of accounting information are relevance and faithful representation. The four enhancing qualitative characteristics are
Relevance and Faithful Representation
Relevant accounting information is information that helps users make decisions. It helps them understand the past or predict the future. For information to be considered relevant, it must have either predictive value or confirmatory value. It also must be material, meaning that its omission could affect the decisions of users.
Faithful representation means that the financial information reflects the substance of economic phenomena rather than just the legal form of a transaction. For example, if a transaction is structured to have the legal components of a sale -- for example, the title is transferred -- but it's clear that both the buyer and seller expect the asset to be returned after a specific period, it would be more faithful to report the transaction as a loan rather than a sale. To be faithfully represented, information should be complete, neutral and free from error.
Relevance and faithful representation are somewhat abstract concepts, so the standard setters employ four enhancing characteristics to help define the fundamental ones.
Comparability means that the accounting information can be compared to information from other companies or entities or to information from other years. Comparability enhances both relevance and faithful representation.
Verifiability means that the accounting information can be verified by some outside source or third party. For example, if a company bases an asset's useful life on an industry report or an expert's estimate, the information is verifiable. FASB does say that information can still be faithfully represented even though its not verifiable, but there's more risk that the information could be wrong.
Timely information is provided to users early enough to use it in the decision-making process. Timeliness is part of the larger concept of relevance. For example, if a company accountant delivers financial statements to a bank after the bank already has offered a loan, the financial statements are not as relevant.
For information to be relevant, it needs to be presented in a way that readers can understand. If a company is reporting something very complex -- for example, the fair value of hedges or derivatives -- the financial statements should contain notes that explain the topics as clearly as possible.