Relevance:
Information should be relevant to the decision making needs of the user. Information is relevant if it helps users of the financial statements in predicting future trends of the business (Predictive Value) or confirming or correcting any past predictions they have made (Confirmatory Value). Same piece of information which assists users in confirming their past predictions may also be helpful in forming future forecasts.
Example:
A company discloses an increase in Earnings Per Share (EPS) from $5 to $6 since the last reporting period. 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.
Relevance is affected by the materiality of information contained in the financial statements because only material information influences the economic decisions of its users.
Example:
A default by a customer who owes $1000 to a company having net assets of worth $10 million is not relevant to the decision making needs of users of the financial statements.
However, if the amount of default is, say, $2 million, the information becomes relevant to the users as it may affect their view regarding the financial performance and position of the company.
Test Your Understanding
Which of the following methods of fixed assets valuation provides more relevant information to users of the financial statements?
Historical Cost Method
Since under historical cost accounting, fixed assets are valued at their original purchase value (less depreciation), their net book value may differ significantly from their true worth to the entity. Users of the financial statements may therefore underestimate the real worth of business assets such as land and buildings.
Revaluation Method
Under revaluation method, fixed assets are revalued as often as required to bring their balance sheet value close enough to their market value. This should result in more relevant information because users will be able to better assess the value of potential benefits from the use or sale of fixed assets (Predictive Value).
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