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Limitations of Financial Statements:

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Sunanda K. Chavan
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Limitations of Financial Statements: - September 13th, 2010

Limitations of Financial Statements:

(1) Financial statements are available only after the specific period of time over. E.g. the Balance Sheet as on 31st March, 2004 is available only after 31st March, 2004 is over. The various legal provisions also provide for sufficient time lag for the preparation of financial statements. Thus, the financial statements give the information about the historic facts which may not be sufficient from decision making point of view for the management.

(2)Financial statements are necessarily interim reports and cannot be final ones. E.g. to understand the correct profitability and to understand the correct position of various assets and liabilities, it will be necessary to stop the business operations and dispose off all the assets and liquidate all the liabilities which may not be practicable and feasible. In order to prepare the financial statements for a specific period, it may be necessary to cut off various transactions involving costs and income at the date of closing the accounts which may involve the personal judgements. Various policies and principles are required to be formulate and followed consistently for such cutting off of income and costs.

(3) As going concern principles is followed while preparing the Balance Sheet, the various assets and liabilities are shown at historical prices and do not necessarily represent the current market prices or the liquidation prices. This may affect the profitability statements as well in the form of incorrect provision for depreciation. This problem may be more critical during the periods of extreme inflation or depression. As such, any conclusion drawn on the basis of such financial statements may be misleading ones.

(4) Financial statements consider only those transactions which can be expressed in monetary terms. All other transactions or factors which cannot be expressed in terms of money are ignored by the financial statements. E.g. Assuming that the business of a company is such that it is likely to be injurious to health of local community. As such, there is a strong opposition from the local community for the company’s carrying on of business at the location. The opposition is something which cannot be expressed in terms of money and hence finds no place in the financial statements though it is affecting the business operations of the company to a very good extent.


(5) The financial statement prepared may be useful for the use of normal users under normal circumstances. If a user wants to use the financial statement for some special purposes, the necessary information or details may not be available from the financial statement. E.g. If an user, on the basis of financial statement available want to value the equity shares of the company with the methods considering earning capital of the company, the required details may not be available from the financial statement. Similarly, the financial statement may not give correct indications about the profitability or the financial conditions of the business under abnormal circumstances. E.g. suppose that the production and sales of a company in a particular year are abnormally high due to the prolonged strike in one of the major competitor companies and hence profits in that particular year are abnormally high. Now when both the sales and profits are at normal level, the performances of that year may be treated as bad as compared to the abnormal year.

Financial statement, howsoever carefully and correctly prepared, do not mean anything all by themselves unless the information stated therein is properly studied, analysed and interpreted. As such merely the preparation of financial statement is not sufficient, equally important is the task of their analysis and interpretation.
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Rose Marry
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Re: Limitations of Financial Statements: - April 14th, 2016

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Originally Posted by sunandaC View Post
Limitations of Financial Statements:

(1) Financial statements are available only after the specific period of time over. E.g. the Balance Sheet as on 31st March, 2004 is available only after 31st March, 2004 is over. The various legal provisions also provide for sufficient time lag for the preparation of financial statements. Thus, the financial statements give the information about the historic facts which may not be sufficient from decision making point of view for the management.

(2)Financial statements are necessarily interim reports and cannot be final ones. E.g. to understand the correct profitability and to understand the correct position of various assets and liabilities, it will be necessary to stop the business operations and dispose off all the assets and liquidate all the liabilities which may not be practicable and feasible. In order to prepare the financial statements for a specific period, it may be necessary to cut off various transactions involving costs and income at the date of closing the accounts which may involve the personal judgements. Various policies and principles are required to be formulate and followed consistently for such cutting off of income and costs.

(3) As going concern principles is followed while preparing the Balance Sheet, the various assets and liabilities are shown at historical prices and do not necessarily represent the current market prices or the liquidation prices. This may affect the profitability statements as well in the form of incorrect provision for depreciation. This problem may be more critical during the periods of extreme inflation or depression. As such, any conclusion drawn on the basis of such financial statements may be misleading ones.

(4) Financial statements consider only those transactions which can be expressed in monetary terms. All other transactions or factors which cannot be expressed in terms of money are ignored by the financial statements. E.g. Assuming that the business of a company is such that it is likely to be injurious to health of local community. As such, there is a strong opposition from the local community for the company’s carrying on of business at the location. The opposition is something which cannot be expressed in terms of money and hence finds no place in the financial statements though it is affecting the business operations of the company to a very good extent.


(5) The financial statement prepared may be useful for the use of normal users under normal circumstances. If a user wants to use the financial statement for some special purposes, the necessary information or details may not be available from the financial statement. E.g. If an user, on the basis of financial statement available want to value the equity shares of the company with the methods considering earning capital of the company, the required details may not be available from the financial statement. Similarly, the financial statement may not give correct indications about the profitability or the financial conditions of the business under abnormal circumstances. E.g. suppose that the production and sales of a company in a particular year are abnormally high due to the prolonged strike in one of the major competitor companies and hence profits in that particular year are abnormally high. Now when both the sales and profits are at normal level, the performances of that year may be treated as bad as compared to the abnormal year.

Financial statement, howsoever carefully and correctly prepared, do not mean anything all by themselves unless the information stated therein is properly studied, analysed and interpreted. As such merely the preparation of financial statement is not sufficient, equally important is the task of their analysis and interpretation.
Hi friend,

Please check attachment for Notes on Financial Highlights and Limitations of Financial Statements - US, so please download and check it.
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