Comparability definition

Comparability refers to the ability to identify similarities and differences in financials. Consistency involves the use of the same methods from period to period within a single entity or the same methodology across various entities during the same period. Comparability and consistency are essential characteristics of useful financial statements. However, various threats to these characteristics may present themselves; and, as accountants, we must be aware of these threats and report them if present. Based on the sample of listed manufacturing companies in China from 2015 to 2019, this paper empirically tests the relationship between accounting information comparability and cost stickiness by regression analysis.

• They also emphasize the different effects of the public disclosure level on the welfare of current shareholders and future shareholders.4 Two important features distinguish our research from the above papers.
• After all, the information processing costs are higher for such firms due to the difficulty of benchmarking and understanding their financial statements.
• International Accounting Standards and International Financial Reporting Standards are the accounting standards that are universally accepted with adjustments according to the specific regulations of different countries.
• IFRS is a standards-based approach that is used internationally, while GAAP is a rules-based system used primarily in the U.S.
• Still, caution should be used, as there is still leeway for number distortion under many sets of accounting principles.
• Although privately held companies are not required to abide by GAAP, publicly traded companies must file GAAP-compliant financial statements to be listed on a stock exchange.

IFRS is a standards-based approach that is used internationally, while GAAP is a rules-based system used primarily in the U.S. IFRS is seen as a more dynamic platform that is regularly being revised in response to an ever-changing financial environment, while GAAP is more static. Therefore, accounting information is relevant if it can provide helpful information about past events and help in predicting future events or in taking action to deal with possible future events. For example, a company experiencing a strong quarter and presenting these improved results to creditors is relevant to the creditors’ decision-making process to extend or enlarge credit available to the company. You wouldn’t be able to compare two companies’ financial information with ratio analysis because their financial information wouldn’t be compatible. You could get a rough estimate on the worth of the company, but an accurate comparison wouldn’t exist.

Meaning of Accounting Principles

Even if firms have sound internal controls, accounting comparability would matter less to investors absent financial reporting transparency. Accrual accounting, by definition, has a discretionary component — for example, allowance for doubtful receivables and estimated warranty reserves. But, we demonstrate that reporting consistently high levels of discretionary accruals compromises a firm’s financial reporting transparency and thereby reduces the benefits of accounting comparability.

Financial statement preparers and other stakeholders should know that high accounting comparability may not yield economic benefits without transparent and reliable financial reporting. So accounting chiefs should pay close attention to the accounting policies of their industry peers and work to improve the quality of their companies’ financial reporting system. Applying a change in the accounting policy retrospectively will help the users in making valid comparisons between current period financial statements and past period comparative financial statements because both will be based on similar accounting policies. However, changes to accounting policy should only be made where required by a change in law or accounting standard or where a change results in a more relevant and reliable information to the users. Section 3 characterizes how comparability affects the cost of capital and investor welfare in an exchange economy. Section 4 extends the analysis to a production economy (i.e., the firm can adjust investments).

WHY IT IS IMPORTANT TO HAVE MORE COMPARABLE GLOBAL ACCOUNTING

This paper is also related to the literature that evaluates the costs and benefits of uniform regimes in reporting information (Chen, Lewis, Schipper, & Zhang, 2017; Dye & Sridhar, 2008; Friedman & Heinle, 2016; Lin, Riccardi, Wang, Hopkins, & Kabureck, 2019). These studies, to some extent, are linked to the definition of comparability in this paper, although they do not directly focus on comparability. Dye and Sridhar (2008) develop a positive theory of accounting standards when standards generate network externalities and differ in flexibility. They evaluate expected value-maximizing firms’ preferences between two standards regimes, rigid and flexible. Friedman and Heinle (2016) examine the costs and benefits of uniform accounting regulation in the presence of heterogeneous firms that can lobby the regulator.

A quality of accounting information that facilitates the comparison of financial reporting of one company to the financial reporting of another company. You wouldn’t be able to compare a company’s performance from year to year let alone two competitors’ financial statements. Without being able to compare and benchmark financial statements, the accounting information would be pretty useless.

Comparability / Consistency

Without these rules and standards, publicly traded companies would likely present their financial information in a way that inflates their numbers and makes their trading performance look better than it actually was. If companies were able to pick and choose what information to disclose and how, it would be a nightmare for investors. Accounting principles differ around the world, meaning that it’s not always easy to compare the financial statements of companies from different countries. Changes to accounting policy must be accounted for retrospectively, i.e. amounts recognized in previous accounting periods are restated to account for the change in accounting policy.

• The issue of differing accounting principles is less of a concern in more mature markets.
• Moreover, these investors typically have access to alternative information sources including electronic newswire services which allow more effective dissemination of firm-specific information (Drake et al., 2014, Kothari et al., 2009).
• A change in the accounting policy may also be imposed by changes in accountancy standards.
• This paper examines the relationship between tax avoidance and accounting comparability.

Holthausen and Verrecchia (1988) argue that the precision of pre-disclosure information signals decreases the informativeness of subsequent firm disclosure, suggesting the substitutive relation among sequential information events. Prior studies also show that earnings announcements are less informative when the quality of pre-disclosure information environments is high (El-Gazzar, 1998, Shores, 1990). Thus, the substitutive role of comparability suggests that comparability likely has smaller room for improving the decision usefulness of earnings information when information https://simple-accounting.org/comparability-principle/ asymmetry is low. Gao (2010) studies how the disclosure quality affects the cost of capital and investor welfare based on a representative firm in a production economy. He shows that a higher quality of information disclosure is not always accompanied by a lower cost of capital and higher investor welfare and that the cost of capital can also move in opposition to the welfare of investors as the disclosure quality changes. On the other hand, Dutta and Nezlobin (2017a) study how information disclosure affects the cost of capital and investor welfare in a dynamic setting.

Accounting information and bid-ask spreads

My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. However, the FASB and the IASB continue to work together to issue similar regulations on certain topics as accounting issues arise. For example, in 2014, the FASB and the IASB jointly announced new revenue recognition standards. CFA Institute is the global, not-for-profit association of investment professionals that awards the CFA® and CIPM® designations. We promote the highest ethical standards and offer a range of educational opportunities online and around the world. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

• This paper is also related to the literature that evaluates the costs and benefits of uniform regimes in reporting information (Chen, Lewis, Schipper, & Zhang, 2017; Dye & Sridhar, 2008; Friedman & Heinle, 2016; Lin, Riccardi, Wang, Hopkins, & Kabureck, 2019).
• Thus, our analysis corresponds well with the theoretical framework indicating that different investors might have different information needs.
• For example, in 2014, the FASB and the IASB jointly announced new revenue recognition standards.
• These critics claim having strict rules means that companies must spend an unfair amount of their resources to comply with industry standards.

The less timely (thus resulting in older information), the less useful information is for decision-making. Timeliness matters for accounting information because it competes with other information. For example, if a company issues its financial statements a year after its accounting period, users of financial statements would find it difficult to determine how well the company is doing in the present. The demand for accounting information by investors, lenders, creditors, etc., creates fundamental qualitative characteristics that are desirable in accounting information. Two of the six qualitative characteristics are fundamental (must have), while the remaining four qualitative characteristics are enhancing (nice to have).

How does IFRS differ from GAAP?

However, in Fang et al. (2018)’s model, there is a benevolent social planner who sets the comparability to maximize the investor’s expected payoffs. We argue that it is more reasonable to allow the firm to choose its accounting policy so that the current investors’ expected utility can be maximized. Second, Fang et al. (2018) focus on the effect of comparability on the informativeness of fundamental earnings in their paper. Our research extends this concept by further exploring the impacts of comparability on the cost of capital and investor welfare.

The presentation of liabilities is different in both years, which is not appropriate as it does not ensure comparability of financial reports/statements. For instance, GAAP allows companies to use either first in, first out (FIFO) or last in, first out (LIFO) as an inventory cost method. Verifiability https://simple-accounting.org/ is the extent to which information is reproducible given the same data and assumptions. For example, if a company owns equipment worth $1,000 and told an accountant the purchase cost, salvage value, depreciation method, and useful life, the accountant should be able to reproduce the same result.

Financial Performance

Accounting principles are the rules and guidelines that companies and other bodies must follow when reporting financial data. These rules make it easier to examine financial data by standardizing the terms and methods that accountants must use. After all, US GAAP gives firms the discretion to choose among alternative accounting methods when it comes to inventory valuation, depreciation calculation, derivative accounting, etc. It also gives managers flexibility in recognizing and measuring contingent liabilities and other transactions. Changes to accounting policy must be accounted for prospectively, i.e. resulting change should not have impact on prior period financial statement comparatives.

• Financial statements are more comparable when the same accounting policies and accounting standards are applied across multiple reporting periods, as well as across multiple entities within an industry.
• When accounting principles allow a choice among multiple methods, a company should apply the same accounting method over time or disclose its change in accounting method in the footnotes to the financial statements.
• Financial statements of one accounting period must be comparable to another in order for the users to derive meaningful conclusions about the trends in an entity’s financial performance and position over time.
• CFA Institute is the global, not-for-profit association of investment professionals that awards the CFA® and CIPM® designations.

The issue of differing accounting principles is less of a concern in more mature markets. Still, caution should be used, as there is still leeway for number distortion under many sets of accounting principles. The ultimate goal of any set of accounting principles is to ensure that a company’s financial statements are complete, consistent, and comparable. Sound internal financial reporting controls is a prerequisite if the value relevance benefits of accounting comparability are to be achieved. The lack of strong internal controls over financial reporting leads to investor skepticism and questions about whether disclosed accounting policies are applied properly.