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OLevel

Accounting - 7707

Limitations of Accounting Statements

Paper-2

Limitations of Accounting Statements
1. Ratios can be used to compare only similar businesses. 

2. Ratios do not take into consideration seasonal fluctuation.

3. Ratios do not take into consideration the effect of inflation.

4. Ratios do not take into consideration the causes of change in the ratio; it only identifies the change.

5. If the financial statements are misleading, the ratios calculated will also be misleading. 

6. People who do not possess complete accounting knowledge cannot derive meaningful information from ratios.

7. Ratios are only useful if they are calculated as soon as the year ends.

8. Delayed calculation of ratios and analysis will be insignificant for the business.

Time factor 

The accounting statement consists of a record of the past. Additionally, there is a gap between the financial year and the preparation of the accounting statement. At that time, important events, for example, changes in inventory levels, non-current asset purchasing, may take place.

Historic Cost

The actual cost price is used to record financial transactions, whereas comparing transactions of different times is difficult due to the impact of inflation. 

Accounting policies 

Accounting policies or businesses shall apply the principles of prudence and consistency, aiding them in making a comparison. A business that has different accounting policies makes it difficult for meaning comparison. Likewise, whenever a business changes its policy, the comparison of previous years also becomes difficult.

Money Measurement

Accounts record information, which is expressed in monetary terms, which means that some significant factors may not appear in the accounting statement, which might affect the performance of the business.

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