LIMITATIONS OF ACCOUNTING
Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. But it suffers from drawbacks which hinders its utility. The Limitations of Accounting are as follows:
INFLUENCED BY PERSONAL JUDGMENTS
Accounting is viewed as Science but it is not an exact science and accountant has to exercise some personal judgments in respect of various items. Accountant has to make varied estimates and appropriations regarding various items like
- Rate of Depreciation
- Method of Charging Depreciation on assets
- Rate of Provision for Doubtful Debts
- Amount of provision for Discount on Debtors
- Methods of valuation of Stock, etc.
Such estimations are charged against profit and loss account and thus do not give an authenticated view of final accounts.
PERMIT ALTERNATIVE TREATMENTS
Accounting follows various concepts and conventions which provides the alternative treatment for the items. One transaction can be treated in two or many ways which makes the results incomparable. For instance: Going Concern Concept states that asset should be recorded at its cost, but at the time of sale of assets it is valued at market price, so this leads to wrong estimations about the sale price of asset.
Similarly, Conservatism Convention states that “Anticipate no profits but provide for all losses”. As per this future losses are provided for in the present but the future income is ignored.
Also there are different methods for valuation of stock like LIFO (Last In First Out), FIFO (First In First Out), Average Stock method etc. and no guidelines are there to chose which method at most.
INCOMPLETE INFORMATION
Accounting statements provide the periodic information which is incomplete as the accounts are maintained as per accounting period concept. However, actual profit or loss can be ascertained only when the business closes down. So the information we get belong to a financial year only not of the whole tenure of the firm.
IGNORES QUALITATIVE INFORMATION
Accounting records only those transactions and events which are financial in nature and can be expressed in the terms of money, but in real world, there is also some qualitative information which is of utmost importance, but is ignored by the Accounting. The qualitative aspects like change in management, loyalty and honesty of employees, hard work of management, good industrial relations etc are totally omitted from the accounting records.
For Example: The conflicts among the management and the employees make the firm run into losses but such information is not recorded in the books of accounts.
BASED ON HISTORICAL COSTS
Accounting is done on the basis of historical costs and the figures shown by the financial statements prepared do not show the price level changes. Also the assets are recorded at the cost price not at the market value and thus remain under-valued or over- valued. All this makes the balance sheet unauthenticated and the financial position cannot be estimated truly. In this way, it does not depict the true present value of the business.
DOES NOT PROVIDE TIMELY INFORMATION
Accounting provides the information by preparing the final accounts which include Trading Account and Profit and Loss Account and Balance Sheet which are prepared at the end of the accounting year. So the management gets the information at the end of the financial year which is just a ‘post-mortem’ analysis of the recorded transactions. However the management requires the information at frequent intervals to plan the best about the upcoming course of action and this purpose is not well catered by the accounting records.
For example: If the business has set a target that it will earn the revenue of ₹12,00,000 in the year, then it requires information whether the earnings in a month is ₹1,00,000 or less or more. Traditionally the accounting will not provide such information at frequent intervals.
AFFECTED BY WINDOW DRESSEING
Window dressing refers to the practice of manipulating the accounts, so that financial statements may disclose a more favorable position than the actual position.
For example: The purchases made at the end of the year may not be recorded or the closing stock may be over-valued. Hence, correct decisions cannot be taken on the basis of such financial information.
UNSUITABLE FOR FORECASTING
Financial Accounts are only a record of past events. Continuous changes take place in the demand of the product, policies adopted by the firm, the position of competition etc. As such, the financial analysis based on the past events may not be of much use for forecasting.
DOES NOT PROVIDE DETAILED ANALYSIS
The Accounting provides the details about the aggregates not the individual items. The Trading Account, Profit and Loss Account and Balance Sheet are just the summaries of the transactions which do not provide the detailed analysis of any transaction or event. So, only overall results of the firm can be studies with the help of the accounting information.
For example: If business has earned a total profit of ₹5,00,000 during the accounting year and it sells three products namely tea, sugar and bread and wants to know the profit earned by each product separately, accounting will not serve this motive.