In this tutorial, we will learn about the limitations of accounting as a language that has its limitations. The assumptions on which accounting is based are sometimes are the limitations of the accounting.
There are certain misconceptions regarding financial statements. A common man presumes that an income statement shows the correct income or loss of the enterprise and that a balance sheet depicts the enterprise’s fair and accurate financial position. Accounting as a language has its limitations. The assumptions on which accounting is based are sometimes are the limitations of the accounting.
It is well established that accounting, especially financial accounting, is of absolute importance. Whether it is the management of the company or other external stakeholders, they depend on these financial statements for their dose of information about a firm’s financial transactions and position. However, accounting is not a perfect science yet.
Whereas the truth is that accounting is not a perfect science or art or language yet. It has been evolving for so many years and continues to grow. The limitations of accounting must be studied to understand it better.
Following are certain instances:
- The factors which may be relevant in assessing the worth of the enterprise don’t find a place in the accounts, as they cannot measure in terms of money such as employee skills, loyalty towards work, etc.
- The balance sheet shows the business’s position on the day of its preparation and not on the future date, while users of accounts (external or internal) are interested shortly.
- With the emergence of AS 11, AS 26, AS 28, etc., market/fair value of assets is considered, but still, there remains some bias as accounting ignores changes in the number of assets like inflation, etc.
- There are incidences where accounting principles conflict.
- The accountant tries a lot so that the accounts are not affected by his judgment, e.g., provision of doubtful debts, methods of depreciation, etc.
- The usage of different policies manipulates the profitability of the enterprise.
- The financial information revealed by them is neither complete nor exact. The financial position or the ultimate gain or loss can be known when the business is closed down.
- Qualitative factors such as the reputation and image of the management with the public, cordial industrial relations and efficiency of workers, customer satisfaction, competitive strength, etc., which cannot express in monetary terms, are not considered by the financial accounting.
- The financial statements are compiled based on the account such factors as the decrease in money value, or increase in the price level changes. Since these statements deal with past data, not with the future, decision-making is of little importance.
- The value of fixed assets in the balance sheet is shown based on the going concern concept. That the value put on an asset rarely represents the amount of cash, which would realize on liquidation. Similarly, the income statement prepared based on conservatism’s convention fails to disclose real income, for it includes probable losses and ignores likely income.