6 Limitations of Financial Statements

Every business organization maintains the proper record of all its transactions during the year in order to keep proper track of its expenses and incomes. At the end of an accounting year, these organizations measure their business performance in terms of profits or losses. Apart from profits or losses, it is also interested in knowing the actual position of its assets and liabilities at the end of an accounting period. Thus, the records maintained by the organizations to ascertain the profits and losses and to assess the financial position of a firm on a particular date are referred to as Financial Statements. The accounting Process ends with the preparation of Financial Statements. Limitations of Financial Statements are as follows

Limitations of Financial Statements

Historical Data: The items recorded in the financial statements reflect their original cost i.e. the cost at which they were acquired. Consequently, financial statements do not reveal the current market price of the items. Further, financial statements fail to capture the inflation effects. Thus, it can be concluded that these statements reflect the data and information of historical nature.

Ignorance of Qualitative Aspects: Financial statements do not reveal the qualitative aspects of a transaction. The qualitative aspects such as colour, size, and brand position in the market, employees’ qualities, and capabilities are not disclosed by the financial statements. These statements record only those transactions that are quantitative in nature and can be expressed in monetary terms.

Biased: Financial statements are based on personal judgment regarding the use of methods of recording. For example, the choice of practice in the valuation of inventory, method of depreciation, amount of provisions, etc. is based on the personal value judgments, which may differ from person to person. Thus, these statements reflect the personal value judgments of the concerned accountants and experts.

Inter-firm Comparison: Usually, it is difficult to compare the financial statements of two companies (either in the same business or in different businesses). This is basically because of the difference in the methods and practices followed by them in preparing their respective financial statements.

Window Dressing: The possibility of window dressing is highly probable. This might be because of the motive of the company to overstate or understate its assets and liabilities to attract more investors or to reduce taxable profits. For example, Satyam showed high fixed deposits in the Assets side of its Balance Sheet for better liquidity that gave false and misleading signals to the investors.

Difficulty in Forecasting: Since the financial statements are based on historical data, so they fail to reflect the effect of inflation. This drawback makes forecasting difficult.

Also, Read

What is Revenue Income?

Revenue Income: Revenue incomes are those incomes that are earned in the conduct of ordinary and day-to-day business activities.

What is Capital Income?

Capital incomes are those incomes that do not arise in the normal course of business operations. Such incomes arise from the capital itself, without involving any production work. For example, the premium received from the issue of shares or debentures.

What is Capital Loss?

The capital loss is made good or settled against the capital profits. In case the amount of capital losses is more than the capital profit, then the excess amount is shown on the Assets side

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