Major Limitations of Financial Accounting

Share this:

Financial accounting is the part of accounting that deals with the recording, posting, and summarizing financial information in an attempt to provide useful data to investors, creditors, and other people outside the business organization. Financial accounting is a set of standards and practices used to help decide how efficiently a business uses its capital. The decisions about which investments are made and how much money is spent on each activity are based on these standards.

Financial accounting represents all aspects of the financial activity because it evaluates, allocates, tracks and verifies individuals or organizations’ financial position by recording its transactions into comprehensive ledgers. It is one of the principal tools for use in modern business management to provide information about an entity’s financial condition. Financial accounting can be extremely useful in an organization, but it does have limitations as well.

No Classification of Expenses and Accounts

Financial accounting does not provide information to analyze the losses that occur due to factors such as idle plant and equipment, volume changes during certain seasons, etc. The expenses are not classified as to direct and indirect items and are not assigned to the products at each stage of production to show how much is spent on materials, labor, etc.

Dependence on historical costs

In the initial recording of transactions, assets and liabilities will be recorded at their cost. This is a concern when reviewing the balance sheet, where the values of assets and liabilities may change over time. Some items, such as marketable securities, are altered to match changes in their market values, but other items, such as fixed assets, do not change. The business needs timely information to enable the management to plan and take corrective action.

Intangible assets not recorded

Some intangible assets are not accounted for as assets on the balance sheet. Instead, any expenditures made to create an intangible asset are immediately charged to expenses. This policy can drastically underestimate the value of a business, especially one that has spent a large amount to build up a brand image or newly develop new products. In order to create enough revenue after developing their product, startups are having trouble maximizing the amount of branding they have developed.

Application of Marginal Costing

No discussion of non-financial issues

Financial accounting takes into consideration only those transactions and events which can be described in money. The transactions and events, however important, if non-monetary in nature are ignored i.e., not recorded. A business that reports excellent financial results might be failing in other areas.

No Data for Comparison

Data on financial performance of a company can’t be compared to data from previous periods or predicted, because financial accounting doesn’t provide information on whether the company is introducing new products, replacing labor with machines, selling at normal or special prices, or producing a part in the factory. Accounting doesn’t differentiate between money and factors. If a certain factor, no matter how important, cannot be expressed in money it finds no place in accounting.

Influenced by personal judgements

Although convention of objectivity is respected in accounting, it is often necessary to make certain estimates-which requires personal judgement. It is very difficult to expect accuracy in future estimates and objectivity suffers. Accounting’s income disclosure is not authoritative, but approximates.

Factors Affecting Elasticity Of Demand

No predictive value

Financial information includes a historical view of a business’ financial performance and the financial status of a business as of a specific date. It does not necessarily provide any value in predicting what will happen in the future.

Subject to error or fraud

One company’s management team may deliberately skew the results presented. This situation can arise when there is undue pressure to report excellent results, such as when a bonus plan calls for payouts only if the reported sales level increases. If a company’s reported figures spike to a level exceeding the industry norm, one might suspect that there’s something wrong.

Share this:

Leave a Reply

Your email address will not be published.