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Accounting Financial Statements – Limitation Of Financial Statements  –  Balance Sheet, Profit and loss account, statement of changes in equity.

In our previous six write-ups on this topic we have continued to point out the general purpose of the financial statements to provide information about the results of operations, financial position, and cash flows of an organisation. Emphasising that these information are used by the users of financial statements to make economic decisions regarding the allocation and reallocation of resources.

As can be seen, in this article number seven, we want to highlight the limitation of financial statements. It is like a caveat, indicating that users must be ware of these limitations. Indeed figures do not give all the details investors need to assess an entity. Complete Full Marks Consultants Limited (CFMC Ltd ) welcomes enquiries for further information on these especially on what it can do to help her client’s businesses grow. It also has in mind of enriching the knowledge of various students who will read these article. Consult us for your business coaching and management needs.

The limitations of financial statements are those factors that a user should be aware of before relying on them to an excessive extent. Knowledge of these factors could result in a reduction of invested funds in a business, or actions taken to investigate further. Ignoring them could lead to serious losses in investments.

Transactions are initially recorded at their cost. Historical cost is the cost at which such items were bought at such a time. This is a concern when reviewing the balance sheet, where the values of assets and liabilities may change over time. Some items, such as marketable securities, are altered to match changes in their market values, but other items, such as fixed assets, do not change. Thus, the balance sheet could be misleading if a large part of the amount presented is based on historical costs. Many business adopt different stock or asset valuation methods.

If the inflation rate is relatively high, the amounts associated with assets and liabilities in the balance sheet will appear inordinately low, since they are not being adjusted for inflation. This mostly applies to long-term assets. Whatever the case may be, inflation alters accounting figures values.

Intangible assets not recorded: 

Intangible assets are those assets that are not physically seen.

Many intangible assets are not recorded as assets. Instead, any expenditures made to create an intangible asset are immediately charged to expense. This policy can drastically underestimate the value of a business, especially one that has spent a large amount to build up a brand image or to develop new products. It is a particular problem for startup companies that have created intellectual property, but which have so far generated minimal sales.

Based on specific time period:

Always compare financial statements of at least three to five years.

A user of financial statements can gain an incorrect view of the financial results or cash flows of a business by only looking at one reporting period. Any one period may vary from the normal operating results of a business, perhaps due to a sudden spike in sales or seasonality effects. It is better to view a large number of consecutive financial statements to gain a better view of ongoing results.

READ ALSO: ACCOUNTING FINANCIAL STATEMENTS

Accounting Financial Statements – Limitation Of Financial Statements

Not always comparable across companies:

If a user wants to compare the results of different companies, their financial statements are not always comparable, because the entities use different accounting practices. These issues can be located by examining the disclosures that accompany the financial statements

This is commonly called Window Dressing. That is a situation where accounting figures are not real or are manipulated.

The management team of a company may deliberately skew the results presented. This situation can arise when there is undue pressure to report excellent results, such as when a bonus plan calls for payouts only if the reported sales level increases. One might suspect the presence of this issue when the reported results spike to a level exceeding the industry norm.

No discussion of non-financial issues:

Non-financial issues are qualitative nature of the entity.

The financial statements do not give account of them. Examples could be; such as the environmental attentiveness of a company’s operations, or how well it works with the local community. A business reporting excellent financial results might be a failure in these other areas. Such qualitative issue can affect company financial positions from time to time.

Not verified:

There is a legal provision that financial statements must be audited annually by independent, external auditors. Any investor relying on an un-audited financial statement is taking a great risk.

If the financial statements have not been audited, this means that no one has examined the accounting policies, practices, and controls of the issuer to ensure that it has created accurate financial statements. An audit opinion that accompanies the financial statements is evidence of such a review.

Tax Management:

Financial statements give rise to tax computations. Incidentally most tax issues are not recorded as financial transactions in the business books. This may mean that tax liability shown is different from what is actual. Where figures are suppressed, tax audit processes could reveal much that could hamper the smooth running of an organisation.

Accounting Financial Statements – Limitation Of Financial Statements

No predictive value:

The information in a set of financial statements provides information about either historical results or the financial status of a business as of a specific date. The statements do not necessarily provide any value in predicting what will happen in the future.

For example, a business could report excellent results in one month, and no sales at all in the next month, because a contract on which it was relying has ended.

Financial statements are normally quite useful documents, but it pays to be aware of the preceding issues before relying on them too much.

We know that we have armed our readers, especially, young entrepreneurs with financial statements facts which we hope will go along way helping them make economic decisions.