Limitation of Financial Statement Video Lecture - Commerce

limitations of financial statements so
financial statements with me the
manufacturing account trading account
profit and loss account and balance
sheet these reflect what is the purpose
of the financial statements to let us
know the results of the operating
activities and to tell us what are the
assets and liabilities on a particular
day at the year however the financial
statements also have certain drawbacks
have certain limitations and when we
read financial statements we should keep
these limitations in mind what are these
briefly let us discover what are some of
these limitations historical cost this
is one of the concepts accounting
concepts that we follow that all assets
when we purchase we record them at the
historical cost the cost at which we
bought but over a period of time for
example land acquired 50 years ago for
one lakh of rupees may be worth a crore
today but it would continue to appear in
the books at its historical cost not
really giving a correct picture about
the value of the assets in the
organization so in the balance sheet the
land would continue to be shown at 1
lakh that is why sometimes there is a
revaluation of assets by which we
increase the value of these assets and
create a reserve called a revaluation
reserve how would the reason that we
maintain historical cost is that it is
objective it is not a matter of opinion
it is the actual price for which we
acquired
the asset another drawback of the
financial statements is that it
considers only transactions which can be
valued in terms of money sometimes in an
organization the biggest assets are its
people but the strength of the people
the strength of the management of the
competence of the management etc are not
reflected in the financial statements
that is why there is a new area called
human resource accounting but usually
financial statements are prepared on a
historical basis and only those
transactions which can be measured in
terms of money are considered perpetual
continuity and periodical account a
business following the going concern
concept a business will continue for a
long period of time to come that is the
basic assumption when we prepare
financial statements and because it will
go on for a long period of time this
long period of time is divided into and
years into periods equal variance of one
year each and financial statements are
prepared so that for each year each such
equal period we can assert eight the
profits and we of course know the
financial position as at the end of that
period
as a result when some expenditures at me
some assets are bought we have to make
an estimate about the life of that asset
this may not always be accurate it is
left to the judgment of the management
to that extent objectivity is lost
another disadvantage would be the
different accounting policies valuation
of fixed assets valuation of inventories
valuation of investments etc can be done
in different ways for example as we have
seen in depreciation the straight-line
method of computing the appreciation may
be followed or a written down value
method or an annuity method or the
number of hours of production method etc
so different organizations may have
different accounting policies so also
with respect to valuation of inventories
where the FIFO method or the weighted
average method etc may be one so it is
possible that different policies are
followed by different forms the
financial statements as they are are
fine if we are making them for one
concern comparing the results year after
year for the same business but we when
we compared different organizations in
the same industry or organizations or
companies of different industries
sometimes compatibility is lost because
of these limitations of financial
statements