What Is Relevance Concept In Accounting? Concept & Examples

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Conversely, the company might report useful financial information that creditors aren’t interested in like employee salaries. Creditors are more concerned about cash flow and profitability—not smaller operational details. Faithful representation means that the financial information presented represents the true economic relevance in accounting substance or state of the item being reported. This does not mean, however, that the representation must be 100 percent accurate, as perfection is rarely attainable. The CPA Handbook indicates that for information to faithfully represent an economic phenomenon, it must be complete, neutral, and free from error.

  1. Under revaluation method, fixed assets are revalued as often as required to bring their balance sheet value close enough to their market value.
  2. Faithful representation means that the financial information presented represents the true economic substance or state of the item being reported.
  3. For example, disclosure about current year revenue is useful in making predictions about revenue next year but it also helps in confirming whether last year prediction was correct.
  4. Relevance refers to the property of information being capable of making a difference in decisions made by users of that information.
  5. Financial annalists and investors can use past financial statements to chart performance trends and make predictions about future performance and profitability.

Relevance means that information is “capable of making a difference in the decisions made by users” (CPA Canada, 2019, QC2.6). The definition is further refined to state that information is capable of influencing decisions if it has predictive value, confirmatory value, or both. Note that although the information may assist in these decisions, the information is not in itself a prediction or forecast. Rather, the information is the raw material used by the decision maker to make the prediction. Confirmatory value means that the information provides some feedback about previous decisions that were made. Quite often, the same information may be useful for prediction and feedback purposes, but in different time periods.

What is Relevance in Accounting?

It should be noted that the presence of both of the fundamental characteristics is required for information to be useful. An error-free representation of an irrelevant phenomenon is not much use to financial-statement readers. Similarly, if a relevant measure cannot be described with any degree of accuracy, then users will not find this information very useful for predicting future cash flows. However, the company suffering a causality loss because the factory burned down to the ground is a relevant piece of accounting information. This information must be included in the financial statements because investors or lenders’ decisions might be affected by this information. Relevance is the concept that the information generated by an accounting system should impact the decision-making of someone perusing the information.

What is meant by the term relevance in accounting?

The information is relevant to investors as it may assist them in confirming their past predictions regarding the profitability of the company and will also help them in forecasting future trend in the earnings of the company. 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. Finally, relevance requires that the financial information given must be needed by the decision maker. For instance, companies could report the type of car their CEO drives in an understandable and timely manner, but this doesn’t make this information relevant.

Examples of Relevance in Accounting

Relevance is affected by the materiality of information contained in the financial statements because only material information influences the economic decisions of its users. A 5-year old income statement doesn’t an investor a lot of good when he is trying to understand the current financial position of the company. In order to be relevant to the investor’s decision making process, the financial information must be current and timely.

Feedback Value

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.