Updated July 21, 2023
Definition of Financial Statement Limitations
Statements, and they are prepared according to the applicable financial reporting framework but this has some limitations like the assets are recorded at historical costs rather than the actual market value and many more.
Every Organization has to prepare Financial Statements as per the applicable financial reporting framework and this contains certain limitations as the organization cannot prepare and present the financial statement as per the convenience of the organization but as per the applicable financial reporting framework and as per applicable laws. Every stakeholder should be aware of the limitations so as to decide the limit of reliance on the financial statements. As financial statements are publicly published hence company or any business organization cannot disclose all the information as there are chances that the competitor may steal the information and use it for its benefit. Hence the organization has to limit itself while publishing public information and follow the protocols disclosed by the law. The other reason being limitations on the financial statements is that any person can manipulate the information and plan the fraud.
Top 10 Financial Statement Limitations
Following are some of the limitations mentioned:
1. Assets are Valued at Historical Cost
In financial Statements long term assets are valued at the price it was purchased long year back and the organizations are not allowed to revalue the same. Hence the current market price is ignored while the valuation of assets and because of its proper financial position cannot be shown as proper wealth cannot be presented in the absolute terms.
2. Some Policies are Judgemental Based
Some of the accounting policies like a method of depreciation, method of amortization, method of measuring cost, a compilation of accounting standards etc. depends upon the judgement of the person using the same. For different methods, the results are different. Hence it puts limitations as a true and fair view cannot be presented properly.
3. Specific Time Period Reporting
Financial statements are reported annually or quarterly. Each period has some upward and downward phases hence each period cannot be compared with the previous period because of the different situations for that period. A reader of financial statements usually compares the financial statement with the previous period whether it is the year or it is the quarter which seems to be limitations.
4. Self-Generated Intangibles are Ignored
In preparation of Financial Statements self-generated intangible assets like credit standing of the organization in the market, the unique quality of product due to which sales targets can be easily achieved etc. are not recorded in the financial statement due to the valuation problems. Hence it is said that the financial statements do not reflect the proper position.
5. Comparability with the Industry Standards
The investor or analyst every time try to compare the financial position and result of the specific company with the Industry standards but they forget that every organization works on different terms, adopt different methods of valuation, adopt different accounting policies which makes them incomparable. Then to the analyst and investors compare the results of a specific company to industry standards to make the investment decisions.
6. Non-Financial Issues are Ignored
Just like the Financial position, Non-Financial issues also affect the organization at large like environmental pollution because of manufacturing, employee turnover ratio, sales return ratio, the building of strong management team, their qualification and perquisites, selection criteria for employees, managers, directors, non-executives etc. these things also greatly affect the performance of the organization.
7. Inflation Effect is Ignored
The assets are recorded at the historical cost. Purchase cost is recorded at the price at which it was initially purchased, the stock is valued at FIFO or LIFO basis. Investments are valued at face value, while debtors and creditors are recorded at actual values. This creates the problem as the inventory is not measured at the current market price, investments are not recorded at the market value and assets are also not recorded as per current values. Which are shown as the assets are either undervalued or overvalued and because of its proper financial position is not reflected.
8. Subject to Judgements and Frauds
As the auditor’s report also stated that the responsibility of the auditor is to verify the figures on the test check basis and the whole responsibility is of the management. And management is the whole and sole of the organization. As it manages the day to day affairs and prepares financial statements as well. Hence the management knows all the flaws, mistakes and loopholes in the accounting system and it can easily manipulate with the figures. Hence there are more chances that the financial statements presented are might not be shown the true and correct position and trying to attract the investors.
9. Subject to Internal Controls and Checks
As the auditor, while auditing the financial statement heavily depends upon the internal controls within the organization and internal checks. The auditor does not thoroughly verify the internal controls and internal checks. He majorly depends upon the internal auditors for that and as internal auditors are the team of management as appointed by the management hence the chances of misappropriations are more.
10. All Financial Statements may not be Audited
Sometimes the branch limit is not applicable for audit and the organization do not get audited the accounts of some non-applicable branches and joint ventures, but we also merge the data in consolidated financial statements. Hence for unaudited statements, there are chances of the frauds and manipulation of the data.
Financial statements usually contain the financial information about the enterprise like balance sheet, profit and loss account, equity statement, cash flow statement etc. the financial statements are to be presented as per applicable financial reporting framework. Hence it puts some limitations while preparing and presenting the financial statements and some of the major limitations are: no uniformity of accounting policies and estimates across the industry as each company use the accounting policies and estimates as per their judgements. Other is the non-financial data is ignored while preparation of the financial statement and there are chances that the information may be vital.
This is a guide to Financial Statement Limitations. Here we discuss the explanation to financial statement with top 10 Limitations in detail. You can also go through our other related articles to learn more –