It is well established that accounting, especially financial accounting is of absolute importance. Whether it is the management of the company or other external stakeholders, they depend on these financial statements for their dose of information about a firm’s financial transactions and position. However, accounting is not a perfect science yet. Let us take a look at some limitations of accounting.
Limitations of Accounting
There are some misconceptions about accounting. Like the fact that a Profit & Loss Statement shows the true profit or loss earned in a year, or that a balance sheet perfectly depicts the financial position of a firm.
Whereas the truth is that accounting is not a perfect science or art or language yet. It has been evolving for so many years and continues to evolve. The limitations of accounting must be studied to understand it better.
Learn more about the advantages of accounting here in greater detail.
One of the biggest limitations of accounting is that it cannot measure things/events that do not have a monetary value. If a certain factor, no matter how important, cannot be expressed in money it finds no place in accounting. Some very important qualities like management, loyalty, reputation, etc find no place on the balance sheet or the income statement.
No Future Assesment
The financial statements show the financial position of the firm on the date of preparation. The users of the statement are more interested in the future of the company in the short term and long term. However, accounting does not make any such estimates.
And due to the dynamic nature of the business environment, a lot can change between such dates. Auditors sometimes do disclose the important events occurring after the balance sheet date to rectify these limitations of accounting.
Accounting often uses historical costs to measure the values. This fails to take into consideration factors such as inflation, price changes, etc. This skews the relevance of such accounting records and information. This is one of the major limitations of accounting.
There is no global standard in accounting policies. In India, we follow the Accounting Standards. Americans follow the GAAP and then there are the international standards, namely the IFRS. And if a global company operates in more than one country, there may be confusion.
Not all accounting policies follow the same line of thinking, and conflicts may arise due to this. It has long been said that the whole world must agree on uniform accounting policies but this has not happened yet.
Sometimes in accounting estimation may be required as it is not possible to establish exact amounts. But these estimates will depend on the personal judgment of the accountant. And estimates are extremely subjective in nature. They are basically a person’s guess of future events. In accounting, there are many cases where such estimates need to be made like provision of doubtful debt, methods of depreciation, etc.
Errors and Frauds
Accounting is done by humans, so there will always be the scope of human errors. There is also the fear of possible manipulation of accounts to cover up a fraud. Since fraud is deliberate, it is that much harder to spot. This is one of the most dreaded limitations of accounting.
Solved Question for You
Q: One limitation of financial accounting is it provides no control on cost. True or false?
Ans: The above statement is True. Financial accounting does not attribute or control costs. There is no proper control of material, labor, overhead costs, etc. However, cost accounting makes provision for this.