Limitations of Financial Statements

Limitations of financial statements

Most of the limitations are due to recorded facts, accounting rules and conventions and personal judgements. If proper care is taken and specifically prepare the financial statements, it reflect the correct financial position of the company. Some of the important limitations are as follows.

Limitations of Financial Statements
Image: Limitations of Financial Statements

1. Incomplete Information

Generally, the financial statements are prepared for an accounting period. Hence, there is a possibility of disclosing incomplete information. The correct financial position and exact financial strength of the company can be known when the business is closed down.

2. No Brief Information

Accounting rules, methods and conventions are applied for preparing financial statements. Sometimes experiences of the accountancy profession is also used for preparation. These lead to detailed information included in the financial statements.

3. Qualitative Information is Ignored

Only quantitative information are included in the financial statements and are expressed in monetary terms. But, the qualitative information such as efficiency of management executives, goodwill of the company, employee and employer relationship, efficiency of workers, customer satisfaction, loyalty of customers, competitive strength and the like are not expressed in monetary terms.

Hence, these are not included in the financial statements. However, these qualitative information are necessary for understanding the real financial position and the operating results of the business.

4. Disclose Wrong Financial Position

The financial position of a business concern is affected by several factors such as economic, social and financial. But, the financial statements include only financial factors. Both social and economic factors are not recorded in the financial statements. This type of practice leads to disclosing wrong financial position of the company.

5. Shows only Historical Information

The financial statements are prepared taking into account of recorded historical costing information. They do not consider present value of money and cost of living index in the price level changes. Hence, historical information has little scope for decision making.

6. Static Financial Position of the Company

A balance sheet is prepared on a specified date and reflects the financial position on such date. The real financial position of the company may be changing day to day. Hence, there is a possibility of window dressing in the Balance Sheet.

7. Financial Statements are Dumb

The financial statements cannot speak themselves. They need detailed analysis and interpretation.

8. Balance Sheet is not a Valuation Statement

Various assets and liabilities are recorded in the balance sheet at their book value. But, the real value is different from the book value. Hence, it is clear that real financial position of the company cannot be judged from the balance sheet.

9. Real Profit is not disclosed by Profit and Loss Account

Both operating expenses and non-operating expenses are recorded in the Profit and Loss Account. They are recorded only on estimation but not on the basis of actual incurred expenses. Hence, there is a possibility of not showing real profit by the Profit and Loss Account.

10. No Comparison of Financial Statements

The financial statements are prepared by different companies in different accounting methods. The reason is that there are different accounting policy and size of business concern differs from one company to another. Hence, the financial statements of two companies cannot be compared.