Understandability

As briefly discussed in the chapter “characteristics of financial information”, understandability is one of the qualitative characteristics of useful financial information. Understandability requires that financial information is presented in such a way that it is understandable to users with basic knowledge and sense of business and financial reporting.

In accounting and financial reporting, there are certain areas which are quite complex in nature and difficult to understand. It must be clear that understandability principle does not mean that complex accounting matters are altogether omitted from the financial information being presented. This principle has nothing to do with the inherent complexity of certain accounting topics such as derivatives and hedge accounting. Understandability principle only requires that financial information is presented in an organized and concise manner so that is easier for the users to navigate, cross refer and understand the financial reports.

Here are some useful examples that can make financial reports understandable for the users.

  • Title of the report should be clear mentioning the name of the entity, type of financial report (for e.g. statutory financial statements, condensed financial information etc.) and period to which it relates.
  • Information should be presented in a systematic way so that it helps the users to grasp the information.
  • Sufficient disclosures should be there in the financial reports to explain various elements of the financial report. For example, for fixed assets, a category-wise movement schedule is usually provided in the note which states the cost at the beginning of the period, purchases and disposals during the period, and closing balance along with similar movement of related accumulated depreciation account.
  • Notes should be properly numbered and cross-referred throughout the financial report.