Lecture 6B: The Conceptual Framework
We've spoken about the fact that the financial information has to have certain qualitative characteristics, and again, keep in mind that when we talk about this, I'm asking, “What is it that my financial statements need to have or contain in order for them to be useful?” I need to make sure that the users that are going to be making decisions on these things find these financial statements useful.
The conceptual framework includes a couple of requirements:
Make sure that your information is relevant. Make sure it's appropriate for the users to base their decisions on. (Make sure that this is what they need.)
So, if you were going to the bank and you say, “Please can you give me a study loan.” and they said, “Okay tell me what we need to know.” and you say, “Well:
I believe I'm a very nice person,
I've got a great sense of humour,
I have about R5 in my pocket, and
I have a lot of friends and a fantastic Facebook profile and everybody loves me.
What information in all that stuff is relevant? It may all be true and it may be great, but the only piece of information that the bank finds relevant within all that stuff you told them is the fact that you've got R5 in your pocket. That's the only information that is useful for them to base their decision on. The fact that you've got a whole bunch of friends on Facebook means nothing to them, they don't care.
So we need to be very careful about understanding who our users are and what they need in order to make sure that our information is relevant for their purposes.
Faithful representation means it should represent what really went on. Make sure that the information is accurate and that you're not lying, that you didn't leave things off or manipulate it.
When the bank is standing in front of you and saying, “Do you think you can pay the loan back?” Obviously you want to say, “Yes, I’m fine.” The reality is, are you fine? Make sure that the information that you represent is true, not because you want it to be true but because it is actually true.
So our two main fundamental qualitative characteristics:
It must be relevant and,
It must be faithfully represented.
Further Qualitative Characteristics
Makes sure that you can compare the information over time, within industries or similar businesses. Different entities should disclose similar transactions in the same way. The idea of comparability is very important because we can identify trends over time.
If you say to me, “I earn R10 000 a month.” I don't necessarily know what that means to you and how you feel about it unless you say to me, “Well, last year I was also earning R10 000 a month. And the year before I was earning R10 000 a month as well.”
That says to me that for the last three or four years, your income has remained the same. Does that say anything to me? Well, it does doesn't it? Versus if you said to me you are earning R10 000 a month now and last year you were only earning R2 000 a month. All of a sudden I feel very differently about the R10 000 a month, right? Because if you were earning R2 000 a month last year, what on earth happened in the meanwhile to make this massive jump? So the information by itself doesn't necessarily give a picture.
When you compare it to what happened last year or what's happening in the industry, then you start to feel that this is quite interesting. If you say to me, “I earn R10 000 a month.”, and I say, “Oh great, what are you doing?”, and you say, “I’m waitressing”, I go, “Wait a minute, I know a couple of waitresses and they only earn R2000 a month. How on earth is that possible?“
It gives me a slightly different feeling about your information because I'm comparing it to other people who are doing the same thing, to what you were doing last year and I'm identifying how I feel about this piece of information based on previous info and time and other people who are doing the same thing. It's really important that our financial information is comparable. You want to compare apples with apples to see what you're looking at.
If someone else comes along and creates the same information, they should come up with the same thing. It needs to be specific, it needs to be concise, and your information needs to be correct, and it needs to be verifiable. You don't just suck it out your thumb; it's got to come from somewhere.
Timeliness is absolutely vital. When you're looking for your results from UNISA you realise that you cannot register for the next semester until you've got the results from last semester. Sometimes you feel it's frustrating, it's got to come on time. You can't get your results from UNISA after you've registered for the next semester - that doesn't help. So certain information is only valuable when it comes on time, because you need to have that information so that you can make the decision for the next step.
It should be drawn up in such a way that average users can get value from it and that they understand it. A lot of companies and people kind of hide what's going on in all the terminology and the long words and the complicated stuff and they intimidate you with all the information. How many times have you read stuff - you've read notes and reports and information, maybe even study information, and you're intimidated by the information? It doesn’t make sense to you; you can’t read it. It means that it's not understandable for the average user.
It also however doesn't mean that something should be left off just because it's difficult. I can’t say, “Well look, you're not going to understand it, so I’m just going to leave it out.” You can’t imagine that we would do that. You can't just say to someone, “Well I know you’re not going to understand it, so I'm just not going to deal with it at all.”
In terms of your financial information what we're asking ourselves is:
What is our conceptual framework?
What are the qualitative characteristics that our financial information needs to have, in order for it to be useful to our users?
It needs to be relevant; it needs to be faithfully represented; it needs to be comparable; it needs to be verifiable; it needs to be timely, and it needs to be understandable. Make sure you know these. More importantly, make sure you understand why they would be important for your financial information.