What is the Relevance Principle? Definition Meaning Example

What is the Relevance Principle? Definition Meaning Example
2023-11-29 愛麗絲羊毛氈

Information is complete if there is sufficient disclosure for the reader to understand the underlying phenomenon or event. This means that many financial disclosures will require additional explanations that go beyond a mere reporting of the quantitative values. Completeness is the motivation behind many of the note disclosures contained in financial statements.

  1. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching.
  2. Similarly, if a creditor wanted to assess the possible future effect on cash flows of a lease agreement, detailed information about the term of the lease, the required payments, and possible renewal options would be needed.
  3. Relevance means that information is “capable of making a difference in the decisions made by users” (CPA Canada, 2019, QC2.6).
  4. Confirmatory value means that the information provides some feedback about previous decisions that were made.
  5. The definition is further refined to state that information is capable of influencing decisions if it has predictive value, confirmatory value, or both.

Predictive value refers to the fact that quality financial information can be used to base predictions, forecasts, and projections on. Financial annalists and investors can use past financial statements to chart performance trends and make predictions about future performance and profitability. FASB asked the question, “Will financial statement users’ decisions be affected by this information? ” If the answer is no, then the information isn’t relevant and can be excluded from the financial statements. If the company suffers a small causality loss because someone threw a brick through the factory-building window, an investor will still invest in the company.

What is Relevance in Accounting?

“Prudence is the exercise of caution when making judgments under conditions of uncertainty” (CPA Canada, 2019, QC2.16). Prudence has historically been described as a cautious attitude that does not allow for the overstatement of assets or income, or an understatement of liabilities or expenses. However, the definition in the Conceptual Framework equally suggests that assets or income should not be understated and that liabilities or expenses should not be overstated. The Framework makes this explicit statement to suggest that asymmetry in standards is not necessary. However, there are examples of specific standards in IFRS that do have unbalanced requirements (i.e. have a requirement for more persuasive evidence when recognizing an income compared to an expense). These types of unbalanced standards are considered acceptable if they result in more relevant and faithfully representative information.

Feedback Value

At the balance sheet date, there is no way to be 100 percent certain that the reported allowance is correct. However, we can still say that the allowance is free from error if we can determine that a logical and consistent process has been applied to determine the amount and that this relevance in accounting process is adequately described in the financial statements. This way, readers are able to make their own assessments of the risks involved in collecting these future cash flows. As mentioned previously, accountants are often faced with trade-offs in preparing financial disclosures.

Relevance and Faithful Representation

Users can make informed decisions and alter their initial stance by being aware of these updates. The third characteristic of relevant information is timeliness because out-of-date information will not be useful for the end user. As noted previously, information that is free from errors is not a guarantee of certainty or 100 percent accuracy. Rather, this criterion suggests that the economic phenomenon is accurately described and the process at arriving at the reported amount has properly applied. For example, at the end of the fiscal year, many companies will make an allowance for doubtful accounts to reflect the possibility that some accounts receivable will not be collected.

These challenges point to the conclusion that accounting is an imperfect measurement system that requires judgment in both the preparation and interpretation of the information. Comparability is the quality that allows readers to compare either results from one entity with another entity or results from the same entity from one year with another year. This quality is important because readers such as investors are interested in making decisions whether to purchase one company’s shares over another’s or to simply divest a share already held.