What are the limitations of financial statement?

Answer 1

Financial statements are based on historical costs and as such the impact of price level changes is completely ignored. They are interim reports. The basic nature of financial statements is historic. These statements are neither complete nor exact. They reflect only monetary transactions of a business. The following limitations may be noted:

1. The financial position of a business concern is affected by several factors-economic, social and financial, but financial factors are being recorded in these financial statements. Economic and social factors are left out. Thus the financial position disclosed by these statements is not correct and accurate.

2. The profit revealed by the Profit and Loss Account and the financial position disclosed by the Balance Sheet cannot be exact. They are essentially interim reports.

3. Facts which have not been recorded in the financial books are not depicted in the financial statement. Only quantitative factors are taken into account. But qualitative factors such as reputation and prestige of the business with the public, the efficiency and loyalty of its employees, integrity of management etc. do not appear in the financial statement.

4. The rupee of 1995, as for example, does not mean the same as the rupee of 2010. The existing historical accounting is based on the assumption that the value of monetary unit, say rupee, remains constant and accordingly assets are recorded by the business at the price at which they are required and the liabilities are recorded at the amounts at which they are contracted for. But monetary unit is never stable under inflationary condition. This instability has resulted in a number of distortions in the financial statements and is the most serious limitation of historical accounting.

5. Many items are left to the personal judgment of the accountant. For example; provision of depreciation, stock valuation, bad debts provision etc. depend on the personal judgment of accountant.

6. On account of convention of conservation the income statement may not disclose true income of the business since probable losses are considered while probable incomes are ignored.

7. The fixed assets are shown at cost less depreciation on the basis of "going concern concept" (one of the accounting concept). But the value placed on the fixed assets may not be the same which may be realized on their sale.

8. The data contained in the financial statements are dumb; they do not speak themselves.

The human judgment is always involved in the interpretation of statement. It is the analyst or user who provides tongue to those data and make them to speak.

Answer 2

One limitation of a financial statement is the fact that it is only reporting for a moment in time. It is a snapshot of the condition of the company.