Limitations of financial accounting

Financial accounting is not free from limitations. Its limitations arc discussed as follows:

Non-recording of non-financial transactions: Financial accounting fails to accommodate transactions and events of non-monetary nature, howsoever important it may be for the organization. For example, quality of product, far-sightedness of management, satisfied and healthy labour-force arc very crucial to the success of an enterprise, but these do not find a place in accounting.

Estimates’ are not accurate: An accountant not only takes the factual information into account, but also has to make estimates as well, which arc often not accurate. For example, estimating the useful life of a machine for depreciation purposes cannot be done with exactness.

Price-level changes are ignored: In accounting, all transactions are recorded at the historical cost, i.e. the cost actually incurred. It totally ignores the changes in the value of assets brought about by changes in the value of money. For example, a fixed asset may have been purchased at Rs. 1, 00,000 in 1990 but will still be recorded in the books of accounts at the same price, even if its value is many times more at present. Hence, it fails to present the true and correct worth of the business.

Conflicting principles: According to the principle of conservatism, stock may be valued at the cost or market price, whichever is less. This implies that current assets are shown by cast in one year and by market price in the other year which shows clear violation of the principle of consistency. Similarly, the change of method of charging depreciation from straight-line method to written-down-value method, and vice versa, highlights the contradiction in applications of accounting principles.

Does not highlight the departmental efficiency or inefficiency: Financial accounting shows the result of an organization as a whole but fails to disclose the departmental contribution or profits and losses. Similarly, if an enterprise is producing and selling different products, it is difficult to ascertain as to which product is profitable and which is not.

Figures are not self-explaining: Even if the accounting information and records are useful to the users, it depends on their ability to analyze and interpret the accounting data for their decision-making purposes. Accounting is the language of business but accounting figures do not speak by themselves. One needs certain tools to make them speak. Every user is not supposed to be competent enough to draw the desired conclusions from the accounting records and data.

No suggestive approach but a past record only: Financial accounting discloses information about the past activities of an enterprise, i.e. what has happened? It does not give any reason as to why or how it happened. If a company makes profits or incurs losses, the financial accounting will only show the amount of profits or losses made, but fail to divulge any details as to why there is increase or decrease in profits or losses, or give any suggestion for future improvement or planning.