What Is Comparability Concept In Accounting? Examples

The comparability concept of accounting states that the users of financial reports of a business must be able to compare these reports with previous years’ reports as well as with reports of other entities dealing in the same industry. Most research documents a gradual increase in cross-country accounting comparability before the years 2000s and a marked increase after IFRS adoption, which, for companies listed in the EU, became mandatory in 2005. The primary objective of financial reporting is to provide useful information for making business decisions. Consistency refers to application of accounting standards and policies consistently from one period to another and from one region to another. The Securities and Exchange Commission (SEC), the U.S. government agency responsible for protecting investors and maintaining order in the securities markets, has expressed interest in transitioning to IFRS. However, because of the differences between the two standards, the U.S. is unlikely to switch in the foreseeable future.

Using a unique setting in Germany, Lin et al. (2019) find that the adoption of IFRS does not lead to a significant incremental increase in comparability beyond the convergence between IFRS and domestic standards. The findings of our study should also be of interest to regulators and standard setters as they assess alternative methods of aligning domestic standards with IFRS. Thus, our study supports the relative importance of comparability, i.e., although important, comparability is secondary to relevance and faithful https://simple-accounting.org/comparability-principle/ representation. The IFRS Framework also regards comparability as an enhancing qualitative characteristic that is not as important as relevance and faithful representation (i.e., fundamental qualitative characteristics). However, regulators usually list comparability as one of the most important reasons to push a set of new common accounting standards. Since comparability itself has no benefits toward reducing the cost of capital, it should be treated prudently to avoid overstating the function of comparability.

Does financial statement comparability mitigate delayed trading volume before earnings announcements?

Unlike their low comparability counterparts, high comparability firms can see their share price rise $6.76 with a $1 EPS increase. Comparability is a quality of accounting information that addresses the usability of financial information. Information that is prepared using the same measurement techniques and reported in a similar fashion is considered comparable information because this information is similar and can be judged side by side other similar financial information.

Our work can also help accounting regulators in the standard setting process and in the post-implementation review of their policies. Comparability is the level of standardization of accounting information https://simple-accounting.org/ that allows the financial statements of multiple organizations to be compared to each other. This is a fundamental requirement of financial reporting that is needed by the users of financial statements.

Output-based measurement of accounting comparability: a survey of empirical proxies

The above finding has an important implication for distinguishing the disclosure preferences of existing and potential investors. With respect to the objective of financial reporting, the frameworks of both the IASB and FASB emphasize that the primary users of general-purpose financial reporting include present and potential investors. Thus, our analysis corresponds well with the theoretical framework indicating that different investors might have different information needs. Accordingly, accounting standards should be designed to balance present and potential investors’ information needs, as investors are the most important users of financial reports.

If a company that retails leather jackets valued its inventory on the basis of FIFO method in the past, it must continue to do so in the future to preserve consistency in the reported inventory balance. A switch from FIFO to LIFO basis of inventory valuation may cause a shift in the value of inventory between the accounting periods largely due to seasonal fluctuations in price. In today’s society, corporate annual reports are in excess of 100 pages, with significant qualitative information. Information that is understandable to the average user of financial statements is highly desirable. It is common for poorly performing companies to use a lot of jargon and difficult phrasing in its annual report in an attempt to disguise the underperformance. Third, our study adds to the literature on investor and analyst reaction to earnings news.

Accounting information and bid-ask spreads

The results of our analyses also imply that the cost of capital is not a valid proxy for the welfare of all investors. Comparability is the degree to which accounting standards and policies are consistently applied from one period to another. Financial statements that are comparable, with consistent accounting standards and policies applied throughout each accounting period, enable users to draw insightful conclusions about the trends and performance of the company over time. In addition, comparability also refers to the ability to easily compare a company’s financial statements with those of other companies. 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.

• Thus, the substitutive role of comparability suggests that comparability likely has smaller room for improving the decision usefulness of earnings information when information asymmetry is low.
• You wouldn’t be able to compare a company’s performance from year to year let alone two competitors’ financial statements.
• Some scholars have argued that the advent of double-entry accounting practices during that time provided a springboard for the rise of commerce and capitalism.
• Our research extends this concept by further exploring the impacts of comparability on the cost of capital and investor welfare.

That is, if investors have less trust in the reported numbers, comparability becomes less of a factor in their valuation decisions. Changes to accounting policies may be required from time to time as a result of changes in law or accounting standards or in instances where a change in accounting policy results in more reliable and relevant information to users of the financial statements. Our study’s key takeaway is that there is an interplay among accounting comparability and other financial reporting characteristics.

Mandatory IFRS reporting around the world: Early evidence on the economic consequences

Thus, the complementary role of comparability suggests that the relation between comparability and ERC will be stronger for firms with low information asymmetry. The qualitative characteristics of accounting information are important because they make it easier for both company management and investors to utilize a company’s financial statements to make well-informed decisions. In this section, we consider a pure exchange economy in which firms’ investments are fixed. The equilibrium trading price is deduced, and then we illustrate how comparability affects the cost of capital and investors’ welfare under this circumstance. Critics of principles-based accounting systems say they can give companies far too much freedom and do not prescribe transparency.

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. This makes it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a period of time. Accounting principles also help mitigate accounting fraud by increasing transparency and allowing red flags to be identified.

Uniform versus discretionary regimes in reporting information with unverifiable precision and a coordination role

Our results contribute to the literature on the costs of tax avoidance and on the determinants of accounting comparability. Further, according to the conceptual framework (FASB, 2010), comparability is a qualitative characteristic of accounting information that enhances information users’ decision usefulness. The insights from the latter analysis (which is our primary research question) have potential to extend the scope of the conceptual framework and complement the prior literature (Gross and Perotti, 2017, Schipper, 2003).

• Comparability allows users to compare financial position and performance across time and across companies.
• Privately held companies and nonprofit organizations also may be required by lenders or investors to file GAAP-compliant financial statements.
• 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.
• The higher the level of internal control is, the weaker the inhibitory effect of accounting information comparability on cost stickiness is.
• 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.