What makes accounting information useful

by

Carrol

The most general and the most important objective of financial reporting is to provide useful information for making decisions. What makes information useful? According to the FASB, the information must be relevant, reliable, comparable, and consistent.

Relevant: For information to be relevant, it needs to be significant enough to influence business decisions. The information should help confirm or correct the users\’ expectations. No matter how significant the information is, however, it must be timely to be relevant. For example, the price of fuel is extremely important information to an airline such as Southwest or JetBlue, and a manager needs this information to make decisions about ticket prices. However, if the firm reports fuel prices only monthly, the information will not be timely enough to be relevant. To be relevant, information must be useful in predicting the future. Currently, the SEC requires firms to submit their financial information within 60 days of the end of the firm\’s fiscal year.

Reliable: When information is reliable, you can depend on it and you can verify its accuracy. The information is completely independent of the person reporting it. To be reliable, the information in the financial statements must be a faithful representation of what it intends to convey, For example, Borders Group Inc. reported $4.04 billion in sales for its fiscal year ended January 28, 2006. This amount must be true and verifiable; otherwise, the information could be misleading to investors. Anyone who examines Borders\’ sales records should come up with the same amount.

Comparable: In addition to being relevant and reliable, useful information possesses comparability. This means investors will be able to compare corresponding financial information between two similar companies-how one company\’s net income compares with another company\’s net income. In putting together financial statements, accountants must allow for meaningful comparisons. Because there are often alternative ways to account for the same transaction within GAAP, companies must disclose the methods they select. This disclosure allows educated investors to adjust the reported amounts to make them comparable. For example, Sears may account for its inventories by averaging the cost of its purchases, whereas Wal-Mart may use a method that assumes the first items purchased are the first items sold.

As a requirement of GAAP, Sears and Wal-Man will disclose these choices in the notes to their financial statements so that investors can compare the inventory information of the companies. Consistent: To be useful, accounting information must be consistent. Consistency is the characteristic that makes it possible to track a company\’s performance or financial condition from one year to the next. Only if a company uses the same accounting methods from period to period are we able to make meaningful comparisons.

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