Limitations of Financial Accounting

Limitations from which financial accounting suffers may be summarized as follow:

1. Historical And Monetary Nature. Emphasis of financial accounting is on recording transactions revenues only after they have occurred, then summarizing and reporting this information at the end of accounting year in the form of profit and loss account/income statement and balance sheet. These statements are general purpose statements and are valuable for external users. Value of these statements for management as a managerial tool is limited because effective management needs not only to know historical costs but also the anticipated costs.

Moreover, for the purpose of planning, budgeting, standard setting, evaluation etc., management also needs non monetary data e.g. kilograms of materials used, direct labour hours worked, machine hours used; maintenance and service hours produced etc. Such non monetary data are out of the scope of financial accounting.

2. Control Over Costs Is Not Possible. In order to exercise control over costs first requirement is to establish cost budgets and standards. Then an efficient system of reporting is required to provide data of actual operations so that wherever unfavourable deviations occ an immediate corrective action can be taken. Financial accounting neither helps in preparing such budgets and standards nor does it help in speedy reporting of actual data. Financial reports prepared on yearly or half yearly basis can serve well the needs of taxing authorities, investors and other outside users, but one year or a half year is too long period of reporting to be effective for control purposes.

3. Does Not Reveal Relative Profitability of Products. Financial accounting measures result of whole business for a given period. While measuring,the totals it may be the case that although business is earning profit yet some of the products are losing money. In this way higher profit earnings of some products are being offset by some unprofitable products. Financial accounts will keep the management in dark as to relative profitability of different products.

4. Does Not Assist In Pricing. As mentioned earlier financial accounting measures total cost after it has been incurred during the accounting period. Many times management is required to submit competitive bids for contracts. In order to submit such a bid, price of the product is to be determined before it is manufactured and before the costs are incurred. In such a situation financial accounting again fails to assist management.

5. Financial Accounts Are Not Classified. Management needs cost information department wise or process wise, job wise or product wise so that in case of deviation from standards responsibility of individuals can be pinpointed and effective managerial control can be exercised. But financial accounts are not so classified to provide such information.

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• Difference between Financial Accounting and Cost Accounting
• Financial Accounting Vs Managerial Accounting
• Management Needs and Accounting
• What is financial Accounting and its primary concern ?