What is Financial Accounting? The financial statements reflect a combination of recorded facts, accounting conventions and personal judgments of the preparers. Definition of Financial Accounting is concerned with providing information to external users. It refers to the preparation of general purpose reports for use by persons outside a Business Enterprise, such as Shareholders (existing and potential), Creditors, Financial analysts, Labor unions, Government authorities, and the like. So, what we were discussing: 10 Key Financial Accounting Limitations help for Better Solution.
The Concept of Financial Accounting is explained there Limitations are very helping for Better Solution.
Financial accounting is oriented towards the preparation of financial statements which summarise the results of operations for selected periods of time and show the financial position of the business at particular dates.
Simple limitations also helpful:
Financial accounting suffers from the following limitations which have been responsible for the emergence of cost and management accounting:
- Does not provide detailed cost information for different departments, processes, products, jobs in the production divisions. Similarly, separate cost data are not available for different services and functions in the administration division. Management may need information about different products, sales territories and sales activities which are also not available in financial accounting.
- Recording and accounting for wages and labor are not carried out for different jobs, processes, products, departments. This creates problems in analyzing the cost associated with different activities. This also does not provide a basis for rewarding workers and employees for the above-average performance.
- Does not set up a proper system of controlling materials and supplies. Undoubtedly, if material and supplies are not controlled in a manufacturing concern, they will lead to losses on account of misappropriation, misutilization, scrap, defectives, etc. They may, in turn, influence the reported net income of a business enterprise.
- It is difficult to know the behavior of costs in financial accounting as expenses are not assigned to the product at each stage of production. Expenses are not classified into direct and indirect, and therefore, cannot be classified as controllable and uncontrollable. Control of cost which is the most important objective of all business enterprise cannot be achieved with the aid of financial accounting alone.
- Does not possess an adequate system of standards to evaluate the performance of departments and employees working in the departments. Standardization is now applied to all elements of the business. Standards need to be developed for materials, labor, and overheads so that a firm can compare the work of laborers, workers, supervisors, and executives with what should have been done in an allotted period of time.
- Does not provide information to analyze the losses due to various factors, such as idle plant and equipment, seasonal fluctuations in the volume of business, etc. It does not help management in taking important decisions about the expansion of business, dropping a product line, starting with a new product, alternative methods of production, improvement in product, etc. Managerial decisions about these business matters have now become vital for the survival and growth of business enterprises.
- Contains historical cost information which is accumulated at the end of the accounting period. This accounting does not provide day-to-day information about costs and expenses. This is the reason why much dissatisfaction has been shown with external financial reporting. Historical cost is not a reliable basis for predicting future earnings, solvency, or overall managerial effectiveness. Historical cost information is relevant but not adequate for all purposes. It is now rightly contended that current cost information should be reported along with historical cost information.
Ten Key Financial Accounting Limitations:
The following points highlight the ten limitations of financial accounting.
Controlling Cost Impossible: In financial accounting control of cost is not possible since the costs are known at the end of the financial year or a specified period of time whether the expense or cost has already been incurred, i.e., nothing can be done to control either the account of expense or the cost. In other words, if it is even found that a particular cost is more, it is not possible to control it. But the same is possible only when the cost accounting system is being introduced.
Recording Actual Cost: The financial accounting records the actual cost only, the historical cost of the assets. The value of assets may be changed, but record only the cost of acquisitions of such assets. In other words, financial accounting does not record the price fluctuations or change in price level. As a result, it does not present the correct information.
Difficulty in Price Fixation: We know that the total cost of a product can be obtained only when all expenses relating to a product have been incurred. That is why it is not possible to ascertain the price of the product in advance for the purpose of the estimated selling price. As total cost (i.e., fixed, variable, direct, and indirect cost of a product) depends on many factors, all such factors cannot be supplied by financial accounting.
Unanimity about: Although there is IASC (International Accounting Standard Committee), the accountants differ in their opinion on the application of accounting principles in the same matter. For example, some accountants prefer to use FIFO method for valuing inventory whereas others prefer to use LIFO or some other method; or, some accountants prefer to use Straight-line Method of depreciation but others prefer to use Diminishing Balance Method etc.
Technical Subject: Since financial accounting is a technical subject, it is not possible for a common man to understand it. Without the proper knowledge of principles and conventions of accounting, it is not possible to analyze the financial data to take any financial decision. Naturally, it has got little value to a person who is not conversant with the subject.
Impossible to Evaluate: Whether the existing accounting principle is sound/correct or not, that cannot be evaluated, i.e., actual performance cannot be compared with the budgeted figure as we can do in case of Standard Costing/Budgetary Control. In other words, the actual result cannot be compared with the budget. Financial accounting presents only the result of the business through profit and financial positions, i.e., the rate of profitability. But the profit may be affected by many of outside factors which are not recorded by financial accounting.
Maybe Manipulated: Financial accounting may be manipulated, i.e., it may be presented as per desire of the management. For example, profit sometimes may be reduced in order to evade tax and to avoid bonus to the employees. On the contrary, more profit may be shown in order to raise fresh equity shares or to pay more dividend to attract the shareholders and others.
Supply Quantitative Information: Financial accounting supplies quantitative information only through absolute figures which do not present always the required information although they are needful to the users. But relative financial information is more important and informative.
Supplies Insufficient Information: Financial accounting provides information about the financial activities as a whole and not individual-wise, i.e., it does not record information relating to product-wise, department-wise etc.
Historic in Nature: Since the financial accounting records all transactions relating to a particular period, it is rather historic in nature. In short, present financial information relating to a past period and not for the future although all financial decisions are taken on the basis of past financial data.
10 Key Financial Accounting Limitations help for Better Solution.
- Controlling Cost Impossible.
- Recording Actual Cost.
- Difficulty in Price Fixation.
- Unanimity about.
- Technical Subject.
- Impossible to Evaluate.
- Maybe Manipulated.
- Supply Quantitative Information.
- Supplies Insufficient Information, and.
- Historic in Nature.