Explain the hierarchy of accounting qualities identified in SFAC No. 2.

Question

What will be an ideal response?

Answer 1

ANSWER:
Decision-makers are at the top of the hierarchy. The specific qualitative characteristics of accounting come under the general heading of decision usefulness, continuing the emphasis on decision-makers and their needs. The two primary, decision-specific qualities are relevance and reliability. Comparability is a secondary qualitative characteristic. Relevance is defined as being capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct expectations. Relevance has two main aspects—predictive value and feedback value—and one minor one, timeliness. Predictive value refers to usefulness of inputs for predictions while feedback value concerns confirming or correcting the expectations of decision-makers. Timeliness is really a constraint on both of the other aspects of relevance. To be relevant, information must be timely, which means that it must be “available to decision-makers before it loses its capacity to influence decisions.”

Reliability is composed of three components: verifiability, representational faithfulness, and neutrality. Verifiability refers to the degree of consensus among measurers. Representational faithfulness refers to the idea that the measurement itself should correspond with the phenomenon it is attempting to measure. Neutrality refers to the belief that the policy-setting process should be primarily concerned with relevance and reliability rather than the effect a standard or rule might have on a specific user group or the enterprise itself.

These qualities are applied within the constraints of benefits greater than cost and materiality. Materiality addresses whether an item is large enough to influence users’ decisions.