Question

Explain the limitations of accounting.

Answer 1

Accounting has several limitations, some of which are as follows:

1. Recording of Financial Transactions: In accounting, only those events which can be measured in money are recorded. Many important non-monetary matters, such as technological progress, labour relations, or employee morale, are ignored. As a result, accounting provides only a partial picture of the business.
2. Lack of Exactness: Accounting is not completely accurate since certain items involve estimation. Examples include stock valuation, charging depreciation, and creating provisions for doubtful debts. These rely on judgement and hence lack precision.
3. Historical Values: Assets are recorded in the books at their original purchase price. Therefore, the Balance Sheet reflects only historical cost and not the current market value of assets, which may show a different financial reality.
4. Window Dressing: Sometimes, accountants may prepare accounts in such a way that they do not reflect the true position of the business. By manipulating accounts, firms may hide expenses or show fictitious assets to present a more favourable picture than the reality.
5. Ignoring Inflation: Accounts are prepared on the assumption that the value of money remains constant. They do not show the effect of inflation, which changes the real worth of assets and liabilities.