Understandability is one of the four enhancing qualitative characteristics of useful financial information. It refers to the classification, characterization and presentation of financial information clearly and concisely.
When financial information is relevant and faithfully represents the underlying economic phenomena, its usefulness is enhanced by comparability, verifiability, timeliness, and understandability.
Understandability assumes that users of financial statements have reasonable background knowledge of business and economic activities. It requires the information presented in financial reports to be concise, complete and clear in presentation. However, understandability does not allow omission of information about any complex economic phenomena altogether from financial statements only due to its underlying complexity/difficulty. It assumes that even knowledgeable people may sometimes require services of an expert/advisor to understand complex economic phenomena.
- Understandability would require financial statements to be identified by presenting the name of the financial statement, the name of the entity and the period covered by the statement. It would also require this information to be repeated wherever needed.
- Understandability also requires the notes and disclosures to be properly numbered and cross-referenced to the primary financial statements (statement of financial position, statement of profit or loss, etc.). For example, the note number of disclosure on leases should be mentioned in front of the lease liabilities line item on the statement of financial position.
- Some derivatives may be very complex specialized instruments. Their valuation often requires application of advanced quantitative techniques. However, understandability does not require us to omit or simplify the required disclosures just because they are not easily understandable. It is because such omission may hurt faithful representation. The conceptual framework does not allow improving an enhancing qualitative characteristic of financial information at the cost of fundamental qualitative characteristics.
by Obaidullah Jan, ACA, CFA and last modified on