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Question

Explain in brief, the limitations of financial accounting.

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Solution

Following are the limitations of financial accounting :

(i) Incomplete information: The accountant measures only those events that are financial in nature, i.e., are capable of being expressed in money. Non-monetary items or events, however significant they may be, are not measured or recorded in accounting, for example, competency of management, competition in the market, industrial relations, etc.

(ii) Inexactness: Accounting data is sometimes based on estimations and it may be inaccurate. Therefore, profits and financial position disclosed by such accounts may not be true and exact. For example, stocks are also valued on some assumptions. Actual useful life of an asset cannot be accurately calculated for the purpose of depreciation.

(iii) Personal influence of accountant: Accounting may be influenced by the personal judgement of the accountant. He applies a choice between different methods of inventory valuation, depreciation methods, provision for doubtful debts, treatment of capital and revenue items and so on. Thus due to lack of objectivity, income measured may not be true in certain cases.

(iv) Assets may not be shown at their real value: Fixed assets are shown at written down value, i.e., cost less depreciation. There may be a great difference between book value at which assets are shown and current replacement cost certain valueless assets are also shown in the Balance sheet, such as, goodwill, patents, and trademark, preliminary expenses, etc.

(v) Effect of price level changes not considered: Accounting statements are prepared at historical cost. Money as a measurement unit changes are considered while preparing Profit & Loss Account, the accounting information will not show true financial results.


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