Understandability is one of the four qualitative characteristics of financial accounting information. The other being relevance, reliability, timeliness, faithful representation, comparability and materiality. Understandability refers to the quality of financial information which makes it understandable by people with reasonable background knowledge of business and economic activities.
Understandability requires the information presented in financial reports to be concise, complete and clear in presentation. The information should be presented so as to facilitate the user of the information.
However, understandability never prescribes any complex information to be omitted altogether due to its underlying difficulty in understanding. It just requires us to disclose the information systematically instead of presenting it haphazardly.
Understandability would require the financial statements to be identified by presenting the name of the financial statement, the name of the entity and the period covered by the statement.
Understandability also requires the notes to be properly numbered and cross-referred to the original balance sheet and income statement items. For example the note number of disclosure on leases should be mentioned in front of the lease payable line item appearing on the face of a balance sheet.
Financial instruments and derivatives are specialized instruments which require rigorous understanding of finance to properly understand the underlying economics. In such complexity we cannot omit the disclosure because it is not easily understandable.
Written by Obaidullah Jan, ACA, CFA