These are some limitations of financial statement that can highly influence the results. Now, we discuss the limitation of the financial statement in detail. You have to follow the whole article till to the end.
Limitations of Financial Statement
1. Historical Costs
Financial reports depend on historical costs. All the transactions are recorded at historical costs. The price of the assets purchased by the Company and thus the liabilities it owes change with time and depends on market factors. The financial statements do not provide the current value of such assets and liabilities. Therefore, if an excessive number of things available within the financial statements supported historical costs and the Company has not revalued them, the words are often misleading. It works as a limitations of financial statement.
2. Inflation Adjustments
The assets and liabilities of the corporate aren’t inflation-adjusted. Suppose the inflation is extremely high. Then, things within the reports will be recorded at lower costs. Hence not giving the readers much information.
3. Personal Judgments
The financial statements are based on personal judgments. The value of assets and liabilities depends on the accounting principle employed by the person or group of persons preparing them. The depreciation methods, amortization of assets, etc., are susceptible to the private judgment of the person using those assets. Therefore, all such forms can’t be stated within the financial reports and are limited.
4. Specific Period Reporting
The financial statements supported a selected period and that also counts into limitations of financial statement. They will impact seasonality or sudden spike/dull within the corporate sales. One period can’t be compared to other periods, It is very easy as many parameters affect the performance of the corporate which is reported within the financial reports. A reader can make mistakes while analyzing supported just one writing period. Looking at pieces from various periods and analyzing can provide a far better view of the performance of the Company.
5. Intangible Assets
The intangible assets of the Company are not recorded on the balance sheet. Intangible assets include brand value, the reputation of the corporate earned over a short time. Which helps it generate more sales, isn’t included within the record. However, if the corporate has incurred any intangible assets expense. it’s recorded on the financial statements. Generally, it is a drag for start-ups that supported the domain knowledge, create an enormous property, but since they need not be in business for long, they could not generate enough sales. Hence, their intangible assets aren’t recorded on the financial statements nor reflected within the sales.
Also Read: Best method to preparation of financial statement
While it’s a standard practice for analysts and investors to match the performance of the corporate with other companies. It is within the same sector, they’re not usually comparable. Due to various factors like the accounting practices used, valuation, and personal judgments made by different companies, comparability is often difficult. It is one of the most essential reasons for limitations of financial statement.
7. Fraudulent Practices
The financial statements are subject to fraud. There are many motives behind having fraudulent practices and thereby skewing the financial results of the corporate. If the management is to receive a bonus or the promoters would like to boost the share’s worth. They tend to point out good results of the Company’s performance by using fraudulent accounting practices, creating fraudulent sales, etc. The analysts can catch these if the Company’s performance exceeds the industry norms. Fraudulent practices are one of the higher effective limitations of financial statement.
8. No Discussion on Non-Financial Issues
Financial statements don’t discuss non-financial issues and just like the environmental, social and governance concerns. Therefore, the steps were taken by the corporate to enhance an equivalent. These issues are getting more relevant within the current generation, and there’s an increased awareness amongst the businesses and government. However, the financial reports don’t provide such information/discussion.
9. It May Not be Verified
An auditor should audit the financial statements; however, they’re of minimal use to the readers if they’re not. If nobody has verified the accounting practices of the corporate, operations, and general controls of the corporate, there’ll be no audit opinion. An audit opinion that accompanies the financial statements highlights various economic issues (if any) within the reports.
10. Future Prediction
Although many financial statements comment that these contain forward-looking information, no prediction about the business might be made using these statements. The financial statements provide the historical performance of the corporate. Many analysts use this information and predict the sales and profit of the Company in future quarters. However, it is prone to many assumptions. Thus, financial statements as a standalone cannot predict the longer-term performance of the corporate.
In this article, we have discussed all the most probable limitations of financial statement. All limitation is very essential to understand and their influence is very high. If you want to learn about the techniques of financial statement analysis then you can follow this article to know detailed information.
1. What are Inherent Limitations of Financial Statements due to their Historical Nature?
Financial statements are based on past transactions and events, thereby inheriting positive limitations due to their historic nature. One of the primary problems is that they no longer reflect the modern-day market cost of belongings and liabilities; alternatively, they gift the value at which they were obtained or incurred, adjusted for depreciation or amortization. This historic fee convention can distort the actual economic function of a company, in particular during times of sizable inflation or deflation. Moreover, economic statements only comprise future potentials or dangers if they have had some financial impact.
2. How does the Use of Judgments and Estimates Impact the Reliability of Financial Statements?
he preparation of monetary statements regularly requires the use of judgments, estimates, and assumptions that could notably impact the reported figures. Estimates are used when the precise cost of an object is only sometimes recognized, including the beneficial lifestyles of an asset for depreciation or the number of doubtful debts. These estimates are inherently subjective and might vary extensively from the final results. Consequently, specific estimations may additionally result in extensively specific suggested consequences, impairing the comparison and consistency of monetary statements.
3. Why is the Assumption of Continuity a Limitation in Financial Statements?
The continuity or going subject assumption presumes that a commercial enterprise will hold its operations into the foreseeable destiny. This means assets are suggested based on their fee instead of liquidation values, and all liabilities are expected to be met when due. However, in reality, businesses face financial distress or maybe bankruptcy. When the going challenge assumption is violated, the premise of accounting changes, which may additionally extensively adjust the translation of monetary statements.