Explaining “qualitative characteristics” from the IFRS Conceptual Framework for Financial Reporting

Helping students to understand, rather than just memorise, IFRS principles

The IFRS Conceptual Framework underpins what international financial reporting standards say and why they identify a particular accounting treatment. Students must understand this if they are to understand wider IFRS principles.

An important aspect of the Conceptual Framework is an attempt to define “high quality” information, or in other words, what makes financial information useful.

According to the Conceptual Framework, useful information has the qualitative characteristics of being relevant, and faithfully represents the underlying event, that is, the words and numbers on the screen or the page should communicate the underlying economic reality.

Now I think of these characteristics as cats – just because it helps me to imagine how these characteristics work. So we have two cats – Relevance and Faithful representation – and they are the primary qualitative characteristics of useful financial information.  

Relevance means that information has predictive or confirmatory value – it can help users to predict future outcomes, for example future profits, or it can confirm or refute previous predictions.  

Faithful representation means a depiction which is complete, neutral and free from error.  

  • Completeness means that all the information that a user needs to understand the economic phenomena is included;
  • Neutrality means that the representation is unbiased, it’s neither overly optimistic nor overly pessimistic.
  • Freedom from error means that there are no errors in the depiction which would make a difference to the economic decision – the information does not have to be completely accurate but it has to be good enough for decision-making purposes.
Photo by Ilse Orsel on Unsplash

Then there are four secondary characteristics known as enhancing qualitative characteristics which also contribute to high-quality information. And I think of these as kittens and they are:

Comparability: good quality information allows users to compare the financial results of a business over time or with other businesses.

Verifiability: different observers are able to agree on what the information means.

Understandability: information should be understandable to users with a reasonable level of knowledge.

Timeliness: information tends to be more useful if it is more current.

These secondary characteristics are kittens because they are enhancing rather than overriding. If there is a conflict between the primary characteristics and the secondary characteristics then the primary characteristic prevails.

For example, you cannot oversimplify information to the extent that it is no longer a faithful representation just to make it more understandable – because faithful representation is a cat (a primary characteristic) and understandability is a kitten (a secondary characteristic).

If the underlying economic phenomenon is complex, and therefore inherently difficult to understand, then its representation will be complex.

Now one final point about quality – in any business decision there is an overriding cost quality trade-off and this is formalised in the Conceptual Framework as the cost constraint.

The costs of reporting better quality financial information need to be justified by the extra benefits of that better quality financial information.

So there is a balance to be struck between maximising the qualitative characteristics of financial information and producing that information at an acceptable cost.

I think of the cost constraint as a big angry dog, Fido, because, well, how else do you keep cats and kittens in line?

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Seminar: The funding butterfly

Toby York and Paul Jennings hosted a Zoom seminar on 18 March 2021

Zoom cloud recording (34 minutes): Toby York demonstrates the “funding butterfly”, part of the Colour Accounting method, which he uses to introduce students to the accounting equation.

StartsContent
00:00Introduction
02:04The BaSIS FrameworkTM
04:35Where to start
06:10Point of view: the pineapple conversation
10:40The funding butterfly
25:35The accounting equation

Zoom cloud recording (9 minutes): Paul Jennings explains some of the practical issues and experiences of implementing Colour Accounting at Winchester University.

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Presentation slides: PPTX | PDF

It’s time to dump the set text

Using H5P to create Colour Accounting interactive content

The days of picking a textbook, downloading the publisher’s resources and setting end of chapter exercises for practise are long gone – and good riddance.

Photo by Gabby K from Pexels

Matt Miller has been calling for educators to Ditch That Textbook for almost 10 years, but most of the academics I speak with tell me that they still use one. I always ask what it is, and in UK institutions, it’s invariably one of about six titles, all similarly structured.

Unprompted, many will go on to say that they or their students don’t particularly like it, and more commonly, that their students don’t read it.

It may not be true of your students, but in my experience, you can’t even give textbooks away. My institution provides students with a set text for each module free of charge using a digital platform. This provides data indicating that some don’t read at all, and very few read a lot.

I can’t say that I blame them entirely. Although I really like my book, I don’t think many of my students would describe it as a good read, or something that they will treasure for years to come.

For teachers, textbooks provide a spine and structure to our courses, and also resources (of variable and questionable quality). They are also, however, a crutch for our teaching and I’ve heard some academics admit that they provide academic respectability. Are these good enough reasons to hang onto them?

The seemingly ever-increasing pressure to provide more accessible, atttractive/interactive and challenging learning materials can feel overwhelming, but I believe it also presents an opportunity.

I am planning a modest start to a project that will create a library of “learning bricks” that can be used to build accounting courses for schools, colleges, universities and perhaps even wider.

The tool I’m playing with is H5P which is a free and open source HTML5 coding platform. This sounds fancy and complicated but it’s actually really easy to use, create, share and reuse content. It can be embedded within most websites and learning management systems, including Moodle, Blackboard, Canvas and Brightspace. In fact, any LMS that uses Learning Tools Interoperability (LTI) standards.

Here are a couple of examples

If you would like to join in with the “Learning Bricks” project or find out more please let me know. Or join the Accounting Cafe community on LinkedIn.

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There’s no such thing as a “prepayment”

The battle to remove “prepayments” from accounting vocabulary is probably not winnable, but we can help our students by being clear about how we describe them.

The battle to remove “prepayments” from accounting vocabulary is probably not winnable, but we can help our students by being clear about how we describe them.

Bringing up four teenage boys, mealtime conversations were often crowded and rowdy affairs. This was encouraged on the basis that arguments develop social, intellectual and emotional intelligences.

Photo by Zach Reiner on Unsplash

I use the word “argument” in the positive sense of reaching a better collective understanding of an issue. Subject matter was always secondary – we argued about anything, and still do.

A good example was the long-running exchanges about “pre-ordering“. One of the boys innocently reported that he’d pre-ordered a new video game. I said no, he hadn’t — he had ordered the game, not pre-ordered it.

He said the game had not been released yet so it couldn’t be ordered. I argued that the status of inventory had no impact on the semantics of ordering. In fact, before Amazon came along I couldn’t recall anybody pre-ordering anything. We placed orders at shops for items that weren’t available, but we never had to “pre-order” anything. And what’s more, I asked, if you did have to pre-order it, when would you place the actual order?

I was triumphant – the boys unmoved.

Life went on undisturbed, other than a potentially explosive episode when a friend of one of the boys popped in some weeks later and said in passing that he had pre-ordered something. The boys looked worried and begged me to let it go. That’s another story.

A few weeks later, I was sharing my frustration after teaching prepayments to my first year under-graduates. It was a concept that they found really tricky.

Immediately, one of the boys pops up “What’s a pre-payment Dad? Surely you can’t pre-pay something. Either it’s paid or it isn’t. Oh, and if it is pre-paid, when do you actually pay it?”.

My first thought was that encouraging debating skills was clearly a mistake, but his challenge lead me to some reflections about prepayments.

Once again, the language that we use is unhelpful. Pre-payment literally means before payment, but we actually mean that the transaction is post-payment and pre-expense activity.

By “prepayment” we mean pre-expense / post-payment.

Admittedly, a bit of a mouthful

So firstly, the “pre–” in prepayment is misleading but secondly, “payment” is also problematic. Most textbooks are clear about prepayments being paid. This one is typical.

“An expense paid for in advance of the benefit being received.”

I’m not so sure. Imagine that on 10 March 2021, an entity is invoiced £30,000 by its agency for an ad campaign that will run over the months of March, April and May, and the costs of the campaign are to be allocated equally over the three months. The agency’s invoice is due for payment on 24 April 2021.

Ignoring sales and value added taxes, at the end of March the entity has incurred expenses of £10,000, it has “prepayments” of £20,000 and a liability to the agency of £30,000. It has paid nothing.

A prepayment is nothing of the sort: it’s not pre-payment and it’s not necessarily a payment. I prefer the term “deferred expenses” and this sits nicely with its cousins.

Deferred expensesAccrued expenses
Accrued incomeDeferred income

The battle to remove “prepayments” from accounting vocabulary is probably not winnable, but we can help our students by being clear about how we describe expenses invoiced in advance, whether they are paid or not.

Goodwill explained in three words

Goodwill represents those ‘unidentified flying assets’ that can’t be individually identified.

Goodwill is one of those slippery concepts that accounting students can find confusing.  Accounting for goodwill brings the student in front of a number of difficult questions and misconceptions in accounting, such as the nature of an asset and the different accounting treatment of definite-life and indefinite-life assets.  

Goodwill is not a new word; it was in general use in the 1300s in the sense of ability or willingness. The Oxford English Dictionary records its use in a business context in 1571 as ‘a transferable privilege allowing the new owner of the business to continue to trade as an established business.’ 

It is worth saying now that lawyers and accountants have very different ideas about what goodwill is and these ideas themselves vary by country. (In the US, less so in the UK, goodwill is inextricably linked with trade marks.) To add to the mix, sometimes accounting textbooks talk about the difference between ‘inherent goodwill’ and ‘purchased goodwill’ and then go on to say that only purchased goodwill can be shown in financial statements.  

Which rather begs the question, isn’t ‘purchased goodwill’ just ‘goodwill’? 

For the purpose of producing a statement of financial position, yes it is.  IFRS 3 defines goodwill as ‘an asset representing the future economic benefits arising from other assets acquired in a business combination (note the emphasis) that are not individually identified and separately recognised’.

In other words, when you account for an acquisition, in the consolidated financial statements, tot up the individually identifiable assets and work out the total.  The amount paid for the business will usually be greater than this first figure. Why? Because there will be other sources of value that can’t be individually identified and recognised as assets, like the propensity of customers to repurchase, well-trained staff, the benefits of increased market share and so on.  

These other sources of value, or future economic benefits,  can be thought of as floating around on top of the separately identified assets – definitely there but difficult to grab hold of and see inside. They are ‘unidentified flying assets’.  

Photo by Albert Antony on Unsplash

These three words are obviously a very simplified explanation of goodwill, but I find that students get the idea very quickly. They then more readily accept the accounting treatment for goodwill and can take part in a more nuanced debate about the quality of different assets.

Later on, we can explore the arguments for and against amortising goodwill and what would happen if the amount paid to acquire a business was actually less than the value of the identifiable assets and liabilities.

© AccountingCafe.org

PowerPoint design rules for educators

With the risk of sounding like the gun lobby, there’s nothing wrong with PowerPoint, only PowerPoint users.

Like it or not, we’re in the communications business and our audiences know what good comunication looks and sounds like. Here are my rules for slide design.

It is not lesson planning software

Use PowerPoint for its designed purpose: presenting content to an audience.

Too often you see presentations where slides serve no purpose other than to remind the presenter what they’re talking about. Even worse are slides used as a tele-prompter for the presenter to read verbatim.

A presentation is a combination of written words, spoken words and images. If the point is made using one of these, you don’t usually need to use one of the others.

Develop a system – stick to it

PowerPoint comes loaded with default slides: layouts, fonts, headings and footers. Most educators use these defaults for years without changing so much as font type or size. Change the default layouts by editing the Slide Master. This is not difficult and once done, you can apply it to all your presentations.

Choose a few simple layouts and a couple of suitable fonts: have one font for headings and one for content, but no more than that, unless you’re a graphic designer. Use an appropriate font size for the presentation environment. It’s difficult to be prescriptive about font size, but remember that some students will be using their mobiles to access materials.

Create your own “Masters” with a simple elegant style that you want to use everywhere

Keep it clean – get rid of junk

Style is a matter of taste (sort of), but even so we tend to agree on good design when we see it. The Apple brand comes to mind.

We’re not all designers and we may not have the time or inclination to worry about pixels, line justifiying and colour matching. So keep things simple.

Use images sparingly, appropriately, and carefully

Slides do not need to be decorated. They need to carry meaning. Just because an image is available doesn’t mean you have to use it. Think carefully about the meaning you are trying to convey.

If you do use an image, give credit where it’s due. We are very clear with students about maintaining high standards of academic conduct and avoiding plagiarism, so model good behaviour in your own materials.

Read, review – read and review again

I get bored correcting the same mistakes that students make – silly typo’s, missing commers; inaccuarte punctuation. You get the picture. But measure your own work by the the standards that you set your students.

We commonly tell our students to read through their work before submitting. I advise mine to read written work out aloud or even better ask a member of the family or a willing friend to read it for them.

Do the same with your own presentations.

A few tricks

  • Amend the “Notes” master so it works as a handout for students. This keeps your handout with your presentation. If you amend the content, you can amend the handout at the same time.
  • Narrate a slide. This way your students can hear you present each slide. It’s no substitute for a live or online lecture but makes for a rather fancy handout. Unlike event recordings, you can change the slide order and the sequence of your recordings are also changed.
  • If you use the same slide time and time again, add it to your “masters”, then insert that slide from the “insert new slide” command.

© AccountingCafe.org

Recommended resources

Duarte is a consultancy and design agency that supports major companies with presentations for leaders and brands. They have excellent free guides and resources on their website to help you improve the effectiveness of your presentations.

SquarePlanet also has great free content. Look for their free eGuide: Code of Content.

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