What is meant by the term relevance in accounting?

Definition of Relevance

In accounting, the term relevance could mean one of the following:

  • An amount, disclosure, etc. that will make a difference to the decision maker
  • Current and future costs only since past costs are sunk costs (except for a tax loss computed using a past cost)
  • Current and future costs that will differ between two alternatives in a decision. (Costs that will not differ are irrelevant and can be ignored.)
  • Information provided in a timely manner

Examples of Relevance

Assume that a company is deciding to replace equipment that has been in use for the past six years. In the decision, the original cost of the equipment and its carrying amount or book value does not have relevance (except in calculating a tax consequence). The reason is that any decision can never undo the past. The decision involves today and the future. Therefore, the relevant amounts for the decision include the cost of the new equipment and the revenues and cost savings that will result from purchasing and using the new equipment. Further, the costs that will remain the same with or without replacing the equipment are not relevant. Examples are the depreciation of the building, salaries of the company's management, etc.

For a company's financial statements to have relevance they must be issued within several weeks after each accounting period ends. To achieve relevance, the financial statements will include some estimated amounts such as the accrual adjusting entries that are part of the accrual method of accounting.

Free Adjusting Entries Cheat Sheet

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