Updated July 20, 2023
Introduction of Relevance in Accounting
In financial statements, the information is useful for the end-user, and based on that, if the user can take appropriate action, then that information is known as relevant in accounting.
The end-user can be internal such as a manager or top executive, or 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. This relevant information may be useful for business managers and outsiders in accounting. 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 have the power to enable the users to predict future scenarios so that users can make appropriate decisions. Furthermore, it is important to note that relevant information may encompass any overlooked adjustments or corrections from previous reports. Users can make informed decisions and alter their initial stance by being aware of these updates. The third characteristic of relevant information is timeliness because out-of-date information will not be useful for the end user.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 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 the company is in a better position to pay back the debt and also growth opportunity is good. 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 presented in a manner that offers comprehensive insights into a company’s historical performance, enabling investors to make informed projections about its future prospects.
- Timeliness is one of the most important factors to qualify for the information as relevant. The information provided by the company should be up to date for the users to make important decisions. Outdated information does not help investors, especially when making future predictions about the firm.
- If management changes past data, it should inform about that correction or adjustment. Based on that, investors can change the prediction of the company’s future. The future decision may get affected by that correction.
Relevance in Accounting Information
- Current and past earnings 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 the Interest coverage ratio 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.
Regulator agencies require the companies to provide the information to investors correctly and promptly. The users must get updated with these disclosures and understand the relevant information. Users can predict and decide about the company based on the relevant information.
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 –