Limitations to financial reporting

Limitations to financial reporting are many times presented with two clear limitations to the information provided by a general purpose financial report that are materiality and cost.

  1. Materiality. Information is material if its omission or misstatement could influence the decisions that users make on the basis of an entity’s financial information. Because materiality depends on the nature and amount of the item judged in the particular circumstances of its omission or misstatement, it is not possible to specify a uniform quantitative threshold at which a particular type of information becomes material. When considering whether financial information is a faithful representation of what it purports to represent, it is important to take into account materiality because material omissions or misstatements will result in information that is incomplete, biased, or not free from error.

  2. Cost. Financial reporting imposes costs; the benefits of financial reporting should justify those costs. Assessing whether the benefits of providing information justify the related costs will usually be more qualitative than quantitative. In addition, the qualitative assessment of benefits and costs often will be incomplete. The costs of providing information include costs of collecting and processing the information, costs of verifying it, and costs of disseminating it. Users incur the additional costs of analysis and interpretation. Omission of decision-useful information also imposes costs, including the costs that users incur to obtain or attempt to estimate needed information using incomplete data in the financial report or data available elsewhere.

Limitations to financial reporting

Preparers expend the majority of the effort towards providing financial information. However, capital providers ultimately bear the cost of those efforts in the form of reduced returns.

Financial reporting information helps capital providers make better decisions, which result in more efficient functioning of capital markets and a lower cost of capital for the economy as a whole. Individual entities also enjoy benefits, including improved access to capital markets, favorable effect on public relations, and perhaps lower costs of capital. The benefits also may include better management decisions because financial information used internally often is based at least partly on information prepared for general-purpose financial reporting.

So it is a balancing act!

And here are some additional remarks, but also keep in mind, better a system with issues than NO system!

9 limitations of accounting

1. Recording only monetary items Limitations to financial reporting
As per accounting principles, only the events measurable in terms of money are recorded in the books of accounts. But events of great importance if not measurable in terms of money is not accounted for.

For that reason, recorded accounting information fails to exhibit the exact financial position of a business concern.

2. Time Value of Money Limitations to financial reporting
Under the accounting system, money value is treated constantly.

But the value of money always changes due to inflation. Under existing accounting systems accounts are maintained considering historical cost ignoring current changed value.

As a result, the accounts maintained fail to exhibit the exact financial position of a business concern.

3. Recommendation of alternative methods Limitations to financial reporting
There exists an application of alternative methods in determining depreciation of assets and valuation of stock etc.

Information regarding the activities of business is expressed in a misleading way if an alternative method is used to achieve a particular object.

4. Restrain of Accounting Principles Limitations to financial reporting
Exhibited accounting information cannot always exhibit a true and fair picture of a business concern owing to limitations of the accounting principles used.

For example,

Fixed assets are shown after deducting depreciation. In the case of inflation, the value of fixed assets shown in the accounts does not correspond to the real position.

5. Recording of past events Limitations to financial reporting
Accounting past events are accounted for.

But naturally, there is no system of recording events that may occur in the future.

6. Allocation of problem Limitations to financial reporting
The allocation process is an important problem in the accounting system. The value of fixed assets is exhausted charging depreciation for the allocated period.

The useful life of fixed assets is fixed up hypothetically which does not stand accurately in most cases.

7. Maintaining secrecy Limitations to financial reporting
Secrecy cannot be ensured for the involvement of many employees in accounting work although maintaining secrecy is very important.

8. The tendency for secret reserves Limitations to financial reporting
Often management creates secret reserves intentionally by increasing or decreasing assets and liabilities for which the total financial picture of an organization is not reflected.

9. Importance of form over substance Limitations to financial reporting
At the time of preparing accounts for a particular period emphasis is laid on form, table, etc. instead of giving importance to an exhibition of substantial information.

See also: The IFRS Foundation

Limitations to financial reporting

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