LIMITATIONS OF FINANCIAL ACCOUNTING

                            LIMITATIONS OF FINANCIAL ACCOUNTING

Advantages of accounting discussed in this lesson do not suggest that
accounting is free from limitations. Any one who is using accounting information
should be well aware of its limitations also. Following are the limitations :

(a) Financial accounting permits alternative treatments

No doubt accounting is based on concepts and it follows "generally

accepted accounting principles", but there exist more than one principle for the

treatment of any one item. This permits alternative treatments within the

framework of generally accepted accounting principles. For example, the closing

stock of a business may be valued by any one of the following methods : FIFO

(First-in-first-out); LIFO (Last-in-first-out); Average price, Standard price etc.,

Application of different methods will give different results but the methods are

generally accepted. So, the results are not comparable.

(b) Financial accounting is Influenced by personal judgementsInspite of the fact that convention of objectivity is respected in

accounting but to record certain events estimates have to be made which requires

personal judgement. It is very difficult to expect accuracy in future estimates and

objectivity suffers. For example, in order to determine the amount of depreciation

to be charged every year for the use of fixed asset it is required to estimate (a)

future life of the asset, and (b) scrap value of the asset. Thus in accounting we do

not determine but measure the income. In other words, the income disclosed by

accounting is not authoritative but approximation.

(c) Financial accounting ignores important non-monetary informationFinancial accounting takes into consideration only those transactions

and events which can be described in money. The transactions and events, however

important, if non-monetary in nature are ignored i.e., not recorded. For example,

extent of competition faced by the business, technical innovations possessed by

the business, loyalty and efficiency of the employees etc. are the important matters

in which management of the business is highly interested but accounting is not

tailored to take note of such matters. Thus any user of financial information is,

naturally, deprived of vital information which is of non-monetary character.

(d) Financial accounting does not provide timely informationFinancial accounting is designed to supply information in the form

of statements (Balance Sheet and Profit and Loss Account) for a period, normally,

one year. So the information is, at best, of historical interest and only postmortem

analysis of the past can be conducted. The business requires timely information

at frequent intervals to enable the management to plan and take corrective action.

For example, if a business has budgeted that during the current year sales should

be Rs. 12,00,000 then it requires information – whether the sales in the first

month of the year amounted to Rs. 1,00,000 or less or more? Traditionally,financial accounting is not supposed to supply information at shorter intervals

than one year.

(e) Financial accounting does not provide detailed analysis

The information supplied by the financial accounting is in reality

aggregate of the financial transactions during the course of the year. Of course, it

enables to study the overall results of the business activity during the accounting

period. For proper running of the business the information is required regarding

the cost, revenue and profit of each product but financial accounting does not

provide such detailed information product-wise. For example, if a business has

earned a total profit of, say, Rs. 5,00,000 during the accounting year and it sells

three products namely petrol, diesel and mobile oil and wants to know profit earned

by each product. Financial accounting is not likely to help him.

(f) Financial accounting does not disclose the present value of the business

In financial accounting the position of the business as on a particular

date is shown by a statement known as balance sheet. In balance sheet the assets

are shown on the basis of going concern concept. Thus it is presumed that business

has relatively longer life and will continue to exist indefinitely, hence the asset

values are going concern values. The realised value of each asset if sold today

can't be known by studying the balance sheet.