What are limitations of accounting?

What are some of limitations of accounting information?

• Answer:

  I. Accounting is only one source of information and primarily provides information based on financial terms: Although this information is vital, decisions cannot be based solely on a monetary basis. Various decisions depend upon a diverse range of issues being considered. A unique combination of Quantitative as well as Qualitative factors should be considered to ensure an effective decision making process. II. The historical perspective of financial accounting: In order to obtain a recent estimate of an entity’s financial performance, the corporate managers carefully scrutinize financial accounting information. In retrospect, this information is based on past performance. The information does provide clarity on the monetary issues but does not provide a definite insight into the strategic future; as the future holds various changes in terms of technology, economic situations as well as political scenarios etc. Such factors in relation to accounting are unpredictable. Therefore, a careful balance between historical accounting as well as the future forecasted outlook is required. III. Historical cost accounting vs. underlying value in use: Some items loose their monetary value over a period of time, but under the financial accounting rules need to be included in financial reports. Though mentioned year after year in the books as monetary figures, the information may be unreliable due to the historical assumptions made on the item’s measurability criterion. For example, a machine in a textile factory is considered to have a useful life which extends over a period of ten years in monetary terms; however, after the period of ten years, the machine may still have the same value as prior years and contribute significantly to the overall operability of the factory. IV. Inability to reflect the true value of strategic management: Various factors such as goodwill and natural circumstances influence the operations of an enterprise; however, these elements are difficult to measure thus, leading to their unavoidable exclusion from financial reports. For example companies depend upon their shareholders, who in turn depend on the performance of the Chief Executive Officers. Although the CEOs may have been hired by the company based upon prior performance, their future performances are not reliably measurable as they may continually vary. In the initial stages, it may be impossible to measure whether the CEO’s presence will deter or appeal to the shareholders, which in turn will influence the profitability of the enterprise. V. Measuring Volatility of external factors: Financial accounting information does not take into consideration volatile and ever increasing changes in the natural and commercial environment. Although scarcely measurable in monetary terms, their unstable nature may have adverse effects if included within the financial reports and have a volatile and cosmetic impact upon the earnings of the firm. For example, tariffs on trade, duties and other environmental issues can have significant short-term volatile effects on the organisation. VI. The effect of non-stable monetary unit: Based from region to region, accounting information is generated at all enterprises based on the assumption that the monetary unit is stable over a period of time. In the real world scenario, the unit fluctuates on a daily basis. Enterprises usually decide on a flat rate to calculate their financing and investing needs. However, this can have adverse impacts which cannot be communicated to shareholders, if the unit has high fluctuations. For example: Indonesia 1995 US$ 1 = RP 6000, 1997 US$ 1 = RP 12000, 1999 US$ 1 = RP 9000. (Figures are approximates, just to provide an insight into the argument about the effects of the fluctuations) From the answer above, it is evident that certain limitations of accounting information have to be taken into consideration before enterprises use merely financial information to aid their decision making process.