Limitations of Financial Accounting

What are the Limitations of Financial Accounting ?

Financial accounting is primarily concerned with the recording of day-to-day company activities and is thus historical in nature. It is nothing more than a post-mortem of previous occurrences.

The profit and loss account, also known as the income statement, is created from the trial balance in order to determine the periodic profit or loss. In addition, the balance sheet or position statement is created to determine the financial status of the firm at the conclusion of the accounting period. 

In most cases, financial accounting provides just a broad overview of a company’s operations. Financial accounting, on the other hand, does not give information regarding the operational effectiveness of these divisions and important company tasks.

As a result, financial accounting is the unifying language of the whole organisation. It expresses itself in monetary terms, aids in the maintenance of systematic records, communicates outcomes, and assures compliance with applicable legal obligations.

The following are some of the Limitations of Financial Accounting is subjected to:

Limitations of financial accounting

1. There is No Provision for Material Control in the Contract

The financial statements of a manufacturing company do not include specific information on the materials used in the manufacturing process.

Although financial accounts record the values of opening and closing stocks as well as the cost of raw materials purchased, they do not record the quantities of raw materials issued to different departments or jobs, nor do they record the prices at which they were issued, even if they are recorded in the books.

Consequently, it is not feasible to determine the cost of raw materials utilised in the production of a specific unit of output using financial accounting methods.

2. The Non-availability of Detailed Information on Labour Costs

Despite the fact that financial statements provide a record of the total salaries given to employees within a specific time, they do not contain the following information:

  • The number of people that are employed
  • The number of employees assigned to various occupations or working in separate departments.
  • Each employee’s total number of hours worked
  • Wage rates are being discussed.

As a result of these considerations, it is impossible to determine whether raising pay or expanding the number of employees will result in a proportional increase in the amount of production using financial statements.

3. Accounting Accounts Are Classified in a General Manner

Accounts are grouped into three categories under the financial accounting system: personal, real, and nominal accounts. A categorization of accounts in this manner does not assist in determining the cost of production by product, by job, by department, by work order, and so on, nor does it assist in determining the cost of production by the department.

4. There is No Separation of Costs into Direct and Indirect Expenses

Costs are not categorised as direct and indirect items in financial statements created under the financial accounting system, and they are not assigned or allocated to each product at each step of production in financial statements prepared under the financial accounting system.

5. Determination of the True Cost of Manufacturing 

Financial accounts are used to keep track of all costs incurred by a company, regardless of whether or not they are related to the cost of production.

As a result, financial records cannot be used to determine the precise or real cost of a product, task, work order, or process. Furthermore, it is not feasible to determine whether or not all of the necessary cost elements have been taken into account when determining the final cost of the project.

6. There is No Provision for a Standardisation System

Managers in a manufacturing company that participates in large-scale production will not be able to directly monitor every action associated with the manufacture of items in their organisation. As a result, standards and objectives for particular tasks must be established in advance.

To detect and build corrective actions when performance falls below predetermined criteria, actual performance should be compared to predetermined standards to find and develop disparities. The financial accounting system, on the other hand, does not make room for such a set of standards.

7. There are No Records of Wastages

When using the financial accounting system, there is no way to track the waste of resources, man-hours, and machine hours that occurs over the process of manufacturing. Consequently, no efforts can be made to eliminate or reduce the many forms of waste that may occur.

8. There is No Assistance in Determining the Selling Price or Calculating the Tender Price

The financial accounting system is unable to provide information on the actual or precise cost of manufacturing. As a result, manufacturers find it difficult to establish a competitive selling price for their goods.

Manufacturers or contractors are often required to submit quotes or bids to potential customers in order to secure the delivery of a significant quantity of a product at a later date or to complete the execution of a contractual agreement. The quote or tender price should be competitive in the marketplace.

The determination of a competitive quote price or tender price may be made based on historical cost data and changes projected in comparison to prior cost levels.

Due to the fact that financial accounting does not provide information about the real cost of manufacturing, the preparation of bids and quotes is time-consuming.

9. There is No Assistance with Cost Containment

Financial accounting does not aid in cost management since it does not include a system of cost control into its structure. This restriction is necessary due to the following considerations:

(a) Costs and expenditures are documented in financial statements only when they have been incurred or spent.Therefore, there is no space for corrective action in financial accounting records.

(b) There are no strategies in financial accounting for determining whether a cost or expenditure is appropriate in any particular situation.

It is not possible to ascribe blame for waste or excessive costs to a specific person or department based on financial accounting records.

10. Financial accounts are only concerned with the overall profitability of a business concern, and nothing else

In order to reveal the total profit or loss of a firm over a specific period of time, financial statements are created. There is no mention of profit margins in the context of products, jobs, processes, or individual departments.

In order to avoid this, it is not feasible to identify the unprofitable operations of a company just on the basis of financial reports. As a result, it is impossible to take the required actions to make them profitable or to put them out of business.

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