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Chapter 1: Question 7Q (page 22)

What is the likely limitation of “general-purpose financial statements”?

Short Answer

Expert verified

Limitations of general-purpose financial statementsinclude the periodic nature of statements, statements not being realistic, lacking objectivity due to personal judgment, reporting only financial matters, and no suggestive approach.

Step by step solution

01

Meanings of Financial Statements

Financial statementsare the statements prepared to provide information regarding the financial position, its operating results and keep track of the cash flows of the business.

02

Limitations of Financial Statements

Financial analysts, advisors, and other interested persons suffer from certain limitations even though financial statements are the back-bones of the decision-making process for different levels of executives of the organization. The reported facts and figures may not be precise, exact, and final. Also, some aspects which may be crucial for decision-making purposes may go unreported.

The following are some of the limitations of financial statements:

  • Periodic nature of statement: The profit or loss arrived at in the profit and loss account is for a certain period. It does not give any idea about the earning capacity over time. Similarly, the financial position as of the balance sheet date is true of that point in time. The likely change in position on a future date is not depicted. The balance sheet estimates and shows the liabilities dependent on future events that are contingent liabilities. They are not accurate figures. Likewise, revenue expenditure is sometimes partly charged to profit and loss accounts and partly deferred or carried forward. The annual statements do not reveal the exact earning capacity in all these respects.
  • The statements are not realistic: Financial statements are prepared based on certain accounting concepts and conventions. As a result, the financial position depicted in the statements cannot be considered realistic. Also, the profit and loss account invariably includes probable losses but does not include probable income. This is according to the accounting convention of conservation.
  • Lack of objectivity due to personal judgment: Values assigned to many items are determined based on the personal judgment of accountants. Hence, relevant amounts shown in the financial statements have no objectivity and are not verifiable. For instance, estimates of the life of fixed assets and the depreciation method are based on the personal judgments of the accountants. The method of valuation to be adopted depends on the policy at the discretion of the management based on their judgment.
  • Only financial matters are reported: The financial statements present information in terms of monetary units. Facts that cannot be depicted in money terms are excluded from the statements. Thus, information relating to the development of skill and efficiency of employees the firm’s public image is not found in the financial statements. Yet these are quite relevant for investors to consider while forming opinions about the firm’s future prospects.

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Most popular questions from this chapter

(Objective of Financial Reporting) Karen Sepan, a recent graduate of the local state university, is presently employed by a large manufacturing company. She has been asked by Jose Martinez, controller, to prepare the company’s response to a current Preliminary Views published by the Financial Accounting Standards Board (FASB). Sepan knows that the FASB has a conceptual framework, and she believes that these concept statements could be used to support the company’s response to the Preliminary Views. She has prepared a rough draft of the response citing the objective of financial reporting.Instructions

  1. Identify the objective of financial reporting.
  2. Describe the level of sophistication expected of the users of financial information by the objective of financial reporting.

In what way is the Securities and Exchange Commission concerned about and supportive of accounting principles and standards?

Question: The authoritative status of The Conceptual Framework for Financial Reporting is as follows:

(a) It is used when there is no standard or interpretation related to the reporting issues under consideration.

(b) It is not as authoritative as a standard but takes precedence over any interpretation related to the reporting issue.

(c) It takes precedence over all other authoritative literature.

(d) It has no authoritative status.

Question: Describe cost depletion and percentage depletion. Why is the percentage depletion method permitted?

ETHICS (Rule-Making Issues) When the FASB issues new pronouncements, the implementation date is usually 12 months from date of issuance, with early implementation encouraged. Karen Weller, controller, discusses with her financial vice president the need for early implementation of a rule that would result in a fairer presentation of the company’s financial condition and earnings. When the financial vice president determines that early implementation of the rule will adversely affect the reported net income for the year, he discourages Weller from implementing the rule until it is required.

Instructions:Answer the following questions.(b) Is the financial vice president acting improperly or immorally?
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