Accounting is a process of collecting, organizing, and analyzing information. It is used in business management to make decisions about products and services, resources, debt and equity, and taxes. The advantages of accounting are that it helps you understand where your money is coming from and where it’s going however accounting has its own limitations. Do you agree on that? Discuss suitable points to support your answer. (10marks)
Answer : Limitations of Accounting
The accounting information is used by various parties who form judgement about the profitability and the financial soundness of a business on the basis of such information. It is, therefore, necessary to know about the limitations of accounting. These are as follows:
1 They do not record transactions and events which are not of a financial character. Hence, they do not reveal a complete picture because facts like quality of human resources, license’s possessed, Locational advantage, business contacts, etc. do not find any place in
books of account.
2 The data is historical in nature. The accountants adopt historical cost as the basis in valuing and reporting all assets and liabilities. They do not reflect current values. It is quite possible that items like land and buildings may have much more value than what is
stated in the balance sheet.
3 Facts recorded in financial statements are greatly influenced by accounting conventions and personal judgements. Hence, they do not reveal the true picture. In many cases, estimates may be used to determine the value of various items. For example, debtors are estimated in terms of collectability, inventories are based on marketability, and fixed assets are based on useful working life. All these estimates are materially affected by personal judgements.
4 Data provided in the financial statements is insufficient for proper analysis and decision making. It only provides information about the overall profitability of the business. No information is given about the cost and profitability of different activities.