LIMITATIONS OF FINANCIAL STATEMENTS :
Financial statements are the result of the accounting process which begins with recording of transactions. Accounting process involves recording, classifying and summarizing business transactions. Financial statements are the result of the third process viz. summarizing. The financial statements are based on certain accounting concepts and conventions which cannot be said to be foolproof.
The following are the limitations of the financial statements:
(i) Financial statements are essentially interim reports and therefore, cannot be final because the final gain or loss can be computed only at the termination of the business. Financial statements only reflect the progress and position of the business at frequent intervals during its life.
(ii) Financial statements though expressed in exact monetary terms, are not absolutely final and accurate. As the balance sheet is prepared on the basis of the going concern concept, asset valuation represents neither the realizable value nor replacement costs. Further, they depend on the judgment of the management in respect of various accounting policies.
(iii) The values ascribed to the assets presented in the statements depend upon the standards of the persons dealing with them. For instance, the method of depreciation, mode of amortization of fixed assets, treatment of deferred revenue expenditure, all depend on the personal judgment of the accountant.
(iv) Financial statements take into consideration only the financial factors. They fail to bring out the significance of non-financial factors which may have considerable bearing on the operating results and financial conditions of an enterprise. For example, public image of the enterprise, the caliber of its management, efficiency and loyalty of its workers etc.
(v) It is not always possible to discover false figures in financial statements. Unscrupulous managements generally resort to ‘window dressing’ in the preparation of such statements.
(vi) Financial statements are prepared primarily for shareholders. Other interested parties have to generally make many adjustments before they use them profitably.
(vii) Quite often, financial statements do not disclose current worth of the business. Only historical facts are presented and the true current worth is not reflected.
(viii) Owing to the fact that financial statements are compiled on the basis of historical costs, while there is a marked decline in the value of the monetary unit and resultant rise in prices, the balance sheet loses its function as an index on current economic realities. Again, the financial statements contain both historical and current costs items, hence figures are distorted.