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TOPIC 7 Reliability or Relevance

TOPIC 7 Reliability or Relevance. Learning outcomes. Understand the linkages between issues of recognition and measurement of reliability and relevance Understand the issue on fair value measurement. Recap. Previous topic - issues of recognition & measurement

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TOPIC 7 Reliability or Relevance

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  1. TOPIC 7Reliability or Relevance

  2. Learning outcomes • Understand the linkages between issues of recognition and measurement of reliability and relevance • Understand the issue on fair value measurement

  3. Recap • Previous topic - issues of recognition & measurement • Unresolved problems of recognition & measurement • Approaches to the problems inevitably tie into issues of relevance & reliability

  4. Qualitative Characteristics Relevance Understand ability Reliability Comparability Feedback Value Predictive Value Verifiability Timeliness Materiality Completeness Neutrality Introduction Representational faithfulness

  5. Introduction • Relevance and reliability are independent to each other • Thus, acctg information may posses varying degree of relevance and reliability • Relevance vs reliability – which one is better to recognize and measure acctg information

  6. Relevance and Reliability –Trade-off • An acctg information is relevant when it is provided in time, but as early stages of information is uncertain and thus less reliable. But if we wait until the information gains reliability, its relevance is lost. • E.g. After the balance sheet date but before the date of issue, a co. wants to dispose of one of its subsidiaries and it is in final stages of reaching the deal but outcome is still uncertain. If the co. waits for more reliable information, that would cost them relevance. Because the information would be outdated and no longer relevant.

  7. Relevance and Reliability –Trade-off • Relevance – is the statistical closeness of the relation between the fundamental (i.e. the firm value to investors) and the acctg numbers • Reliability – is the closeness between the benchmark (i.e. what it purports to represent) and the acctg numbers • Different users might have different views about the trade-off because they might have different needs and objectives

  8. Relevance and Reliability – Trade-off • Preparers • May emphasize on reliability • To ensure auditability of fin statements • Investors prefer objectivity and integrity of information • If not reliable – regulatory sanctions • Prefer historical value than fair value

  9. Relevance and Reliability – Trade-off • Investors • Prefer fair value – to determine the true value of investment • Prefer historical value – to assess the cash flows management of a company/assess stewardship function • Historical cost vs fair value • Reliable vs relevance

  10. continue • However, fair value acctg measurements are unreliable if there is no quoted market price – these lead to lack of reliability and comparability of fin statements • Thus, relevance and reliability – both are important because relevant information that is not reliable is useless to investors.

  11. Things to ponder • What do you think? Is the historical cost principle or fair value better for financial reporting? • The fair value can be completely replaced by the historical cost? • Historical cost, is it completely reliable?

  12. Reliability • To assess reliability of acctg info: • Compare acctg numbers to economic benchmarks • Examining restatements of acctg info • Compare acctg estimates against future cash flows • Infer the impact on reported acctg numbers from external incentives • Infer reliability of acctg info from the use of the info in capital markets

  13. Continue • 4 factors that reduce reliability • Uncertainty between current economic construct and future cash flows • Human errors and biases • Model limitations • Data limitations

  14. Continue • Factors influence reliability of acctg info. • External incentives • Effect of incentives with characteristics of fin reporting standards • Knowledge/expertise • Information processing biases and errors

  15. Reliability Faithful representation Conceptual Framework for Fin Reporting 2010 • Different views from users of CF on reliability trigger the Board to review reliability • Thus, propose faithful representation encompasses all of the qualities previously included as aspects of reliability. • Faithful representation – is the depiction in financial reports of the economic phenomenona they purport to represent

  16. Continue Why is verifiability not a component of the faithful representation? • If verifiability is part of faithful representation, some information could be excluded from fin reporting. • e.g. An entity may show that an information on management’s opinion or intention may be useful for dm. But the information may not be directly or indirectly verifiable. Thus, the Board concluded that verifiability is not part of faithful representation. • Verifiability – merely enhancing qualitative characteristics.

  17. Conclusions • Qualitative characteristics of financial reporting • Issue on historical value and fair value measurements

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