Question

Explain any three limitations of analysis of financial statements.​

Answer 1

Answer:

The following are all limitations of financial statements:

1. Dependence on historical costs.
2. Inflationary effects.
3. Intangible assets not recorded.
4. Based on specific time period.
5. Not always comparable across companies.
6. Subject to fraud.
7. No discussion of non-financial issues.
8. Not verified.

Answer 2

Answer:

Financial Statement Limitation # 1. Only Interim Reports:

These statements do not give a final picture of the concern. The data given in these statements is only approximate. The actual position can only be determined when the business is sold or liquidated. However, the statements have to be prepared for different accounting periods, generally one year, during the life time of the concern. The costs and incomes be apportioned to different periods with a view to determine profits etc.

The allocation of expenses and incomes will depend upon the personal judgment of the accountant. The existence of contingent assets and liabilities also makes the statements imprecise. So financial statements do not give the final picture and they are at the most interim reports.

Financial Statement Limitation # 2. Do not Give Exact Position:

The financial statements are expressed in monetary values, so they appear to give final and accurate position. The value of fixed assets in the balance sheet neither represents the value for which fixed assets can be sold nor the amount which will be required to replace these assets. The balance sheet is prepared on the presumption of a going concern.

The concern is expected to continue in the future. So, fixed assets are shown at cost less accumulated depreciation. There are certain assets in the balance sheet such as preliminary expenses, goodwill, discount on issue of shares which will realize nothing at the time of liquidation though they are shown in the balance sheet.

Financial Statement Limitation # 3. Historical Costs:

The financial statements are prepared on the basis of historical costs or original costs. The value of assets decreases with the passage of time current price changes are not taken into account. The statements are not prepared keeping in view the present economic conditions.

The balance sheet loses the significance of being an index of current economic realities. Similarly, the profitability shown by the income statement may not represent the earning capacity of the concern. The increase in profits may be due to an increase in prices or due to some abnormal causes and not due to increase in efficiency. The conclusions drawn from financial statements may not give a fair picture of the concern.

Financial Statement Limitation # 4. Impact of Non-Monetary Factors Ignored:

ADVERTISEMENTS:

There are certain factors which have a bearing on the financial position and operating results of the business but they do not become a part of these statements because they cannot be measured in monetary terms.

Such factors may include the reputation of the management, credit worthiness of the concern, sources and commitments for purchases and sales, co-operation of the employees, etc. The financial statements only show the position of the financial accounting for business and not the financial position.