Do you know Limitations of Accounting in 2022 ?

Limitations of Accounting

As discussed above, accounting provides information about the profitability and financial soundness of a concern to the owners and other interested parties. In addition, it provides various other valuable information’s also. However, accounting has certain limitations which must be kept in mind while using such information’s.

These limitations are as follows :

(1) Influenced by Personal Judgements :-

Accounting is as yet an exact science and accountant has to exercise his personal judgement in respect of various items. For example, it is extremely difficult to predict with any degree of accuracy the actual useful life of an asset which is needed for calculating depreciation. The same is true about method of valuation of stock and making provision for doubtful debts. Different persons are bound to have different opinions in respect of such things and hence it will result in ascertainment of different figure of profit or loss of a business by different persons. Hence the figure of profit cannot be taken as an exact figure.

(2) Based on Accounting Concepts and Conventions :-

Accounts are prepared on the basis of a number of accounting concepts and conventions. Hence, the profitability and the financial position disclosed by it may not be realistic. For example, fixed assets are shown in the balance sheet according to the historical cost concept’. This means that the fixed assets are shown at their cost and not at their market value. The values realised on their sale may be more or less than the values stated in the balance sheet. Similarly, on account of convention of conservatism, the profit & loss account does not disclose the true profit of the business because future losses are provided whereas future incomes are ignored.

(3) Incomplete Information :-

Accounting statements provide only the incomplete information because the actual profit or loss of a business can be known only when the business is closed down.

(4) Omission of Qualitative Information’s :-

Accounts contain only those information’s which can be expressed in terms of money. Qualitative aspects of business units are completely omitted from the books as these cannot be expressed in monetary terms. Thus, changes in management, reputation of the business, cordial management-labor relations, firm’s ability to develop new products, efficiency of management, satisfaction of firm’s customers etc. which have a vital bearing on the profitability of the firm are all ignored and omitted from being recorded because all of these are qualitative in nature.

(5) Based on Historical Costs :-

Accounts are prepared on the basis of historical costs (i.e., the original costs) and as such the figures given in financial statements do not show the effect of changes in price level. The assets remain undervalued in many cases particularly land and building. The outcome of this practice is that balance sheet values of assets are not helpful in estimating the true financial position of the business. .

(6) Affected by Window :-

Dressing Window dressing refers to the practice of manipulating accounts, so that the financial statements may disclose a more favorable position than the actual position. For example, the purchases made at the end of the year may not be recorded or the closing stock may be over-valued. Hence, correct decisions cannot be taken on the basis of such financial statements.

(7) Unsuitable for Forecasting :-

Financial Accounts are only a 7 events. Continuous changes take place in the demand of the product, policies adopted by the firm, the position of competition etc. As such, the financial analysis based on past events may not be of much use for forecasting.

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