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 does not reveal the true balance sheet of the firm. This article is going to discuss those limitations for better understanding of accountancy.
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 an estimation. The reason behind is that not all accounting can be done establishing 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 the different form of accounting policies. 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 the accounting by referring to the right tutorial site which can help them develop a clear understanding of the chapter.
Two of the major drawbacks of historical accounting are as follows:
Depreciation is charged
Price changes are not considered
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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 organisation makes are recorded in this accounting process and a financial statement is formulated. The financial statements are inclusive of cash flow statement, income statement, a statement containing retained earnings and balance sheet. 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.