What is the Limitation of Accounting?
From the management of the company to the management of other stakeholders, financial accounting is highly important. The process of management is greatly dependent on the financial statements. These statements provide management with a comprehensive idea about the financial status of the company, its investment, position, and transaction. However, it is important to understand that there are certain limitations of financial accounting which do not reveal the true balance sheet of the firm. This article is going to discuss those limitations for a better understanding of accountancy.
The Various Limitations of Accounting
Besides studying accounting, it is also important to understand the limitations of accounting. These limitations have been discussed below:
Historical Costs - To measure the values, accounting considers historical costs. However, this process does not allow considering important areas of accounting like inflation, price changes and similar things as such. Further, this reduces the importance of accounting information and records. Hence, historical costs are considered to be one of the important limitations of accounting.
Estimates - Another important limitation of accounting is estimation. The reason behind is that not all accounting can be done to establish the exact amount and hence it is essential to estimate. But the drawback in such a scenario is that the accountant makes the estimation based on his or her judgment. This estimation is extremely subjective as they are based on the assumption of future events. Such estimation results in doubtful debts and often at times leads to depreciation.
Verifiability - The correctness of the financial statement or for that matter an audit, cannot be guaranteed. The verification of the statements depends only on the judgment and ability of the auditor and hence creates plenty of limitations in accounting.
Measurability - Events or things that do not have monetary value cannot be measured in accounting. Such events or things include management, reputation, loyalty, and dedication which cannot be expressed in money and therefore has no place in accounting. These important qualities are responsible for the growth of the organization but they cannot be measured and put in financial statements. Thus it becomes one of the important limitations of financial accounting.
No Future Assessments - The financial statements prepared are based on the date or the period of preparation. But when it reaches the authorities of the company to assess the future position of the firm it does not have any clarification as it does not provide the record of the present. All businesses are dynamic and change is inevitable. To understand more about this limitation, the student can refer to the limitations of accounting Class 11.
Errors and Frauds - These two limitations are the most common ones in accounting. Error is ought to happen as the financial statements are prepared by humans and not machines and fraudulency occurs whenever there is the involvement of manipulation or similar other external or internal factors. These factors are very hard to recognize and rectify at the same time. Thus, this limitation is highly dangerous for any business or firm.
Accounting Policies - Though mentioned last, this is one of the most common problems that is faced by all organizations across the world. The reason is that every accounting department follows a different form of accounting policy. While Indians follow the global accounting standards, Americans follow the GAAP. However, if a multinational company operates in more than one country it is prone to create confusion and conflict. This is the reason why there is a sheer need for uniform accounting policies to eradicate this limitation from accounting. The student will be able to learn more about accounting by referring to the right tutorial site which can help them develop a clear understanding of the chapter.
What are the Two Major Drawbacks of Historical Accounting?
Two of the major drawbacks of historical accounting are as follows:
Depreciation is charged
Price changes are not considered
Why Choose Vedantu?
There are numerous reasons why students may want to choose Vedantu over other tutorial sites. Some of the reasons have been listed below:
If you are a student you can avail any information, solution, and guide from the site.
Best curated teachers come together at Vedantu fulfilling the objective of interactive and comprehensive learning.
It is the only tutorial site that provides master classes for a student from class 6 to class 12 and also prepares the student for IIT JEE
This is a site not only meant for students but teachers. There are career options as well which an individual can explore.
FAQs on Limitations of Accounting
1. How do businesses deal with the limitations of accounting?
Accounting comes with various forms of limitations like measurability, errors and frauds, account policies and similar things as such. Accounting in business are ought to create limitations in a way or another as the process of business consistently changes and so is the working pattern and objective of humans. A significant number of firms reveal their future goals only after the presentation of the financial sheet to cover up the limitations of accounting.
2. What is financial accounting?
The process of reporting the business transaction of a company through recording and summarizing is referred to as financial accounting. The business transactions that an organization makes are recorded in this accounting process and a financial statement is formulated. The financial statements are inclusive of cash flow statements, income statements, a statement containing retained earnings, and balance sheets. It can be of various types, such as accrual accounting, cash accounting, etc. By availing limitations of accounting PDF students will have an elaborate understanding of this topic.
3. What is financial accounting? Discuss the benefits of accounting.
Financial accounting refers to a particular branch of accounting that consists of a brief process that includes recording, summarizing, analyzing, and reporting the plethora of transactions that tend to take place as a result of business operations over a specified period of time. Its primary aim is to prepare structured and organized financial reports that keep a track of a business firm’s performance for tax authorities, investors, etc., i.e., to external parties. Basically, these financial reports are available for public use.
There are various benefits of financial accounting and they are as follows:
It not only helps to prevent fraud, but it also helps in detecting the same by recording all the data that the management tends to use for analytical purposes.
All the transactions of a business are recorded with the help of financial accounting; it’s a great and organized way to maintain all sorts of business records.
Financial accounting also helps with the preparation of financial statements that help to discern the profit and/or loss of an organization and determine its true value.
It also serves as legal evidence of all the recorded data and can be used for settling down disputes and/or disagreements between businesses and firms.
4. What is historical accounting and what are its drawbacks?
There takes place a calculation of the value utilized in the overall process of accounting wherein the majority of the assets, if not all, are to be recorded strictly at their historical cost on the balance sheet. This is known as the concept of historical accounting. However, there are two big drawbacks when it comes to the system of historical accounting, the first being the fact that depreciation is charged, and the second is that the change in prices is not considered.
5. What is the application of accounting in daily life?
Accounting is not only a useful and valuable tool for business organizations and firms, it is also colossally helpful when it comes to everyday life. A common yet great example is using accounting to keep a track of the daily activities of a business like expenditure, savings, management of your funds, etc. It helps to maintain as well as expand the financial health of a particular business by tracking its overall performance, its cash flows, etc. And in a more personal and individual sense, accounting provides one with acute financial awareness.
6. State drawbacks of financial accounting. If there are so many limitations of accounting, then how do business organizations deal with them?
The limitations of financial accounting are as follows:
Although accounting helps with recording all kinds of data when it comes to the assets, losses, profits, etc., of an organization, the information it provides is still considered to be insufficient because there is no elaborate information on departments, products, etc.
There are chances that management might end up manipulating the information that is presented by financial accounting.
There is a lack of a cost control method, i.e., it doesn’t play any significant role in controlling the expenses of a firm or an organization.
Its nature is historic; financial accounting fails to provide data based on daily activities and only provides data for past activities.
No matter how vital accounting is for businesses, it still has a number of drawbacks from errors and frauds to account policies. However, these limitations are unavoidable and inevitable considering the fact that businesses are ever-changing and so is the way humans work and what their objective is. So, firms are more or less aware of how they’re going to come across such setbacks in some way. To avoid these, many firms choose to reveal their future goals and purposes after they have presented their financial sheet.
7. How is studying with the help of Vedantu beneficial for students?
With easy and free access to guides, carefully curated study material, and other such information, the presence of myriads of experts and teaching authorities online, Vedantu helps to fast-track the studying and learning process of students and helps them to achieve their goals. Not only that, but with a multitude of career options to explore and choose from, Vedantu also makes it easier for students to plan for their future ahead.