Accounting can be defined as a systematic approach to recording business transactions and verifying and analysing them.
Accounting can be of many types: government accounting, management accounting, etc. Financial accounting is one of the accounting branches.
In financial accounting, accountants identify, measure and record the business transactions before classifying and summarising them. There are multiple advantages of accounting but limitations of accounting that can not be ignored.
In this article, we will explain the limitations of accounting in a briefly for better understanding. Limitations of accounting class 11 is an important topic in financial accounting. Before summarising the limitation of accounting we will define the basic meaning of financial accounting in simple terms.
Financial Accounting
Financing accounting is an important branch of accounting. In this form of accounting, financial transactions of businesses are recorded, summarised, and reported for a particular time period. Financial statements include cash flow statements, balance sheets, and income statements for a specific time period.
Financial accounting is based on various principles like the Economic entity principle, Conservatism principle, Matching principle, Accrual principle, etc. Financial accounting has various advantages like systematic maintenance, taxation, performance analysis, etc. But apart from these advantages, there are some limitations of accounting like recording only monetary transactions, ignoring price changes, etc.
Limitation of Accounting
Limitations of accounting are those factors that might bother investors, stakeholders, management, and directors of the financial statement of the company at the time of making any decision, by only considering these statements. There are various limitations of accounting in financial accounting apart from the advantages. They are as follows:
Monetary Information Only
One of the major limitations of accounting is that it notes down the transactions that are in monetary terms or can be purchased or sold in exchange for money. Accountants ignore non-financial events or terms in accounting but impact the firm’s business in great aspects.
Goodwill, competition, laws and regulations, etc. are non-monetary factors but they affect the company’s operation. These non-monetary factors have a great impact on the company’s image which doesn’t appear on the financial statement.
Window Dressing
Accounting transactions or information might be manipulated by accountants to show the financial worth of a company in powerful aspects. By adopting an alternate method of noting or recording the transaction, the assets or net profit of a company can be decreased or increased. So, another limitation of accounting is that it can be window dressed as per the management’s requirements.
Impact of Inflation or Deflation
In financial accounting, accountants record the value of the fixed assets on a historic basis but ignore the concept of economic crises like inflation and deflation. This is a limitation of accounting where the financial statement will not present the current situation of a company.
Every economy has a high inflammation, however financial accounting doesn’t include these changes in the balance sheet thus weakening the sheet.
Personal Bias
This is one of the limitations where the accounting books are prepared by the accountant. Although these statements i.e. cash flow statement, balance sheet, and income statement, are prepared to keep in mind the basic principles, these require the personal judgement of the accountant and his experience.
However, those may vary depending on the competence and experience of the accountant while preparing the financial statement.
Ignore Non-tangible Assets
Financial accounting ignores various intangible assets such as the value of a brand, patent, etc., while recording the financial statements. However, while recording the accounting statements expenditures at the time of generating those assets are being recorded. For example, there will be an amount to be paid for registering a patent, but as a patent is an intangible asset then the only expense would be recorded but not the patent.
This presents a weak picture of the company’s balance sheet and company’s net worth.
The Unknown Real Value of Fixed Assets
In accounting, the value of fixed assets is recorded at the cost price and depreciated at a particular amount, regardless of their actual condition. The balance sheet doesn’t show the updated value of fixed assets, which changes over time. This principle of accounting fails to present the actual position of business financial status. In other words, the actual value of the business may differ from the current condition of the assets.
Conclusion
Although there are various benefits of accounting in the broad aspect, there are other factors that can’t be ignored. These factors of accounting are the limitations of accounting. These factors affect the decision of the users i.e., managements, investors, etc.
In the above article, we have discussed the limitations of accounting. Hopefully, the above article has solved all your queries regarding the various limitations of accounting in financial accounting.
