Continuing to explore basic financial accounting concepts and assumptions, which are used to prepare financial statements, the next one is understandability.
It is important accounting concept, which means that financial data presented in the financial statements must be clear. It has to be ensured that users without any specific accounting knowledge and specific education are able to understand the information, which is provided.
In case there are certain difficult or complex items included in the financial statements, they should be explained in the notes to the financial statements.
The next accounting concept is materiality. Only material items are included in the financial statements, which might have an impact on the decisions made by the users of the financial statements.
Immaterial or minor items are grouped together and it is not necessary to disclose them separately. It is important to remember that disclosure and presentation of immaterial items is costly comparing to the usefulness of such data to the users of the financial statements.
Relevance & Reliability
The other two accounting concepts applicable to preparation of financial statements is relevance and reliability. The essence of this concept is that only relevant information, which might be useful for the users of financial statements should be presented thereof. Information presented in the financial statement also should be reliable.
All economic substance of the event, transaction must be reflected. Financial statements must include complete records about the business, its results of operations, assets and liabilities and equity.
It has to be ensured that users of the financial statements are able to compare financial data about the business with other businesses and also across several accounting periods covering the same business. Therefore the notes to the financial statements become very important and must explain any reasons or circumstances, if there are any, why such comparison is not possible.
Substance Over Form & Completeness
One more accounting concept is substance over form. Application of this concept leads to the requirement that the real essence of the transaction must be reported and it is essential to disclose its real economic reality, but not its legal form. Also it is essential to comply with the completeness concept, i.e. all items might be complete. The substance behind this requirement is that if some information, which might be important to the users of financial statements, is not completely disclosed, financial statements might be misleading to their users and wrong decisions might be made based on such misleading data.
Neutrality & Faithful Presentation
The next accounting concept is neutrality, which means that financial statements must be free from errors or from other missions. Financial statements cannot be prepared with the purpose to influence certain decisions, i.e. they might be neutral. Users of the accounting data should have the ability or possibility to make their own decisions based on that information.
One more accounting concept is faithful presentation, which means that transactions and business facts must be presented faithfully. This concept is closely related to the reliability, i.e. it must be ensured that information provided in the financial statements is reliable. Only if this is a case the users of financial statements can make correct decisions based on the financial data provided thereof.