Introduction of Relevance in Accounting
In financial statements, the information which is useful for the end-user and based on that if the user can take appropriate action then that information is known as relevance in accounting. The end-user can be internal such as a manager or top executive or can be an external user such as a creditor or potential investor.
A piece of information is relevant if it provides an actionable insight or can make a difference in the decision making of the end-user. In accounting, this relevant information may be useful for both business managers or outsiders. This information may be seen in the company’s financial statements or the investor presentation. For the information to be relevant to users, it must provide details about past events and it should have the power to enable the users to predict future scenarios so that users can take appropriate decisions. Also, relevant information can include some adjustments which were missed in past reports, and by seeing these corrections or adjustments, the user can change his decision. The third characteristic of relevant information is timeliness because out of date information will not be useful for the end-user.
Examples of Relevance in Accounting
Below can be the examples of relevance in accounting information:
- A company is looking to raise debt for future growth. For that purpose, potential creditors check the financial statements of the company. If by looking at financial statements, creditors can assume that company is in a better position to pay back the debt, and also growth opportunity is good then creditors can choose the amount of debt and interest rate on debt. Based on this financial information, the company’s CFO also estimates the interest rate on debt and then based on the discussion with creditors final interest rate can be decided.
- An investor wants to invest in company ABC. Before investing, he evaluates the company’s past performance, future strategy, and growth opportunities. Based on the relevant information he prepared the decision to invest or not to invest in the company.
- Company ABC wants to acquire company XYZ. To evaluate whether it is the correct target and what should be the approximate valuation for the bidding purpose, it looks into XYZ’s financial statements and future earning opportunities. It also analyzes the risk factors based on the reports and management presentations. This information can be termed as relevant information for the decision making for company ABC to acquire XYZ or not and if yes then what should be the approximate valuation.
Relevance in Accounting Standards
Information is relevant if it affects the decision making of end-users. Below are the standards of relevance in accounting:
- Information should be provided in such a way that it gives details about the past performance of the company and based on these details an investor can make predictions about the company.
- To qualify for the information as relevant, timeliness is one of the most important factors. The information provided by the company should be up to date for the users to make important decisions. Outdated information does not help investors in any way especially when they are trying to make future predictions about the firm.
- If management is changing some past data then it should inform about that correction or adjustment. Based on that, investors can change the prediction of the future of the company.The future decision may get affected by that correction.
Relevance in Accounting Information
Below kind of information can be seen as relevant in accounting:
- Current and past earning per share to understand the trends and to predict the future.
- Change in net cash over the years to understand how much income is converting into cash.
- Debt ratios such as Interest coverage ratio which would be useful for current and potential creditors to check the credit level of the company.
- Depreciation and amortization schedule of the assets to evaluate the future schedule and total useful life of the assets.
Regulator agencies require the companies to provide the information to investors correctly and promptly. The users need to get updated with these disclosures and understand the relevant information. Based on the relevant information users can make a prediction and decide about the company.
This is a guide to Relevance in Accounting. Here we also discuss the introduction of Relevance in Accounting Information along with examples. You may also have a look at the following articles to learn more –
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