The limitations of financial statements are such aspects that a user must be well aware of, before depending upon them to an enormous amount. Knowledge of these aspects can result in a devaluation of invested capital in a trading concern or actions taken to analyse further.
The following are the limitations of financial statements:
- Dependence on historical costs: Transactions are documented at their cost. This is interest when analysing the balance sheet, where the values of assets and liabilities might vary over time. A few items, such as marketable securities, are modified to equal the changes in their market values, however, other items, namely – fixed assets, don’t change. Hence, the balance sheet might be ambiguous if a large chunk of the amount depicted is grounded on historical costs.
- Biased: Financial statements are the results of the documented facts, accounting notions and conventions utilised and personal decisions made in distinct scenarios by the accountants. Therefore, bias may be noticed in the outcomes and the financial position shown in financial statements may not be practical.
- Significant data missing: Balance sheet does not reveal the data that is associated with loss of markets and end of agreements, which have an important aspect on the business.
- Aggregate information: Financial statements depict average data but not explained data. Therefore, they may not assist the users in making decisions.
- Assets may not realise: Accounting is performed on the ground of a few definite conventions. Some of the assets might not realise the declared values if the liquidation is enforced on the enterprise. Assets shown in the balance sheet reflect slightly at an unexpired cost.
- They are only interim reports: Statement of Profit and Loss reveals the P/L for a defined period. It does not furnish an idea about the earning capability over time correspondingly, the financial position reflected in the balance sheet is appropriate at that point of time, the likely change on a future date is not shown.
The above mentioned is the concept, that is elucidated in detail about the Limitations of Financial Statements for the class 12 Commerce students. To know more, stay tuned to BYJU’S.