Limitations of Financial Accounting

The main reason for the development of cost accounting is the limitations of financial accounting. Hence,
causes for the development of cost accounting and limitations of financial accounting are one and the
same.

The main causes for the development of cost accounting or Limitations of financial accounting are
briefly explained below.

1. Financial Accounting gives the net result of the trading or manufacturing concern for a specific period.
It does not provide the result in product wise or process wise or area wise or branch wise.

2. Financial accounting does not provide the data relating to the cost of goods manufactured. Hence, the
company is not able to fix the reasonable price, price reduction during depression, formulating marketing
policies etc.,

3. The conversion of a losing unit into a profitable one through cost control is possible with the help of
financial accounting records.
4. Financial Accounting does not provide means for controlling different elements of cost, reduction of
expenses, elimination of wastage, measurement of level of efficiency etc.,

5. The day-to-day income and expenses of a business concern are available from the financial records.
Hence, the company is not able to control the cost.

6. Financial Accounting information is not useful for taking a decision relating to closing down a unit
apparently making loss, introducing a new product or product-mix, entering into the foreign market etc.,

7. Financial Accounting fails to locate a place that is main spot of inefficiency in an organization.
Moreover, there is no tool or scale of measurement for measuring the level of efficiency in operation.
Limitations of Cost Accounting
Besides a number of advantages, cost accounting sufferers from a number of limitations. Some of them are
mentioned below:

1. Lack of uniformity:
Cost accounting lacks a uniform procedure. It is possible that two equally competent cost accountants may arrive at
different results from the same information. Keeping this limitation in view, all cost accounting results can be as
mere estimates.

2. Conceptual diversity:
There are a large number of conventions and flexible factors such as classification of cost into its elements, issue
materials on average or standards price, apportionment of overhead expenses, arbitrary allocation of joint costs,
division of overhead into fixed and various and variable costs, division of cost into normal and abnormal and
controllable and non-controllable and adoption of marginal and standard costs due to which it becomes difficult to
have exact costs. In which a contacts, the reliable of cost accounting might be low.

3. Costly:
There are many formalities which are to be observed by a small and medium size concerned due to which the
establishment and running costs are so much that it becomes difficult for their concerned to afford us cost. Thus it
can be used only by big concerned.

4. Ignorance of futuristic situation:

The contribution of cost accounting for heading futures situation has not been much for example, it is has not
evolved so far any tool for heading inflation situation.

5. Lack of double entry systems:

Under cost accounting. A double entry system is not adopted that does not enable to checks the arithmetic's accuracy
of the transaction and locate the errors.

6. Developing stage:
Cost accounting is to development stage since its principle concepts and conversions are not fully developed.
Limitations Of Management Accounting
Though management accounting is helpful tool to the management as it provides information for planning,
controlling and decision making, still its effectiveness is limited by a number of reasons. Some of the
limitations of management accounting are as follows:

1. Based On Accounting Information

Management accounting is based on data and information provided by financial accounting and cost accounting. As
such the correctness and effectiveness of managerial decisions will depend upon the quality of data provided by cost
and financial accounts. So, effectiveness of management account is limited to the reliability of sources of
information.

2. Lack Of Knowledge
The use of management accounting requires the knowledge of number of related subjects. Deficiency in knowledge
in related subjects like accounting principles, statistics, economics, principle of management etc. will limit the use of
management accounting.

3. Intensive Decisions
Decision taking based on management accounting that provide scientific analysis of various situations will be time
consuming one. As such management may avoid systematic procedures for taking decision and arrive at decision
using intuitive. And intuitive limit the usefulness of management accounting.

4. Management Accounting Is Only A Tool

The tools and techniques of management accounting provide only information and not decisions. Decisions are to be
taken by the management and implementation of decisions are also done by management.

5. Evolutionary Stage
Management accounting is still in a development stage and has not yet reached a final stage. The techniques and
tools used by this system give varying and differing results. It is still named as internal accounting and/ or
operational accounting.

6. Personal Prejudices And Bias

The interpretation of financial information may differ from person to person depending upon the capability of the
interpreter. Analysis and interpretation of data and information may be influenced by personal basis. As such, the
objectivity of decision may be affected by personal prejudices and bias.
LIMITATIONS OF AUDITING
What are the limitations of auditing? As we know that audit is the independent examination of financial information
of any entity, whether profit oriented or not, and irrespective of its size, or legal form, when such an examination is
conducted with a view to expressing an opinion thereon.There are many advantages of auditing but there is also
several limitations of auditing. Let’s discuss in detail various limitations of auditing.

1. FRAUDS BY MANAGEMENT: Auditing fails to verify planned frauds. The management can settle
thickly to operate the accounts in order to cover up their inefficiencies. The frauds committed in such
circumstances are not revealed. The audited accounts could not show the true and fair outlook.
2. WRONG CERTIFICATES: Auditing is based on many certificates taken from management and other
persons. The certificates may not provide the true information. Auditing may fail to provide the desired
results Auditing. When certificates provide wrong information, the financial statements cannot show
correct position.
3. MISLEADING CLARIFICATION: Auditing fails to disclose correct information. The background of
entries may not be clear to audit staff. The management may not provide correct clarification. The auditor
is bound to present his report even of the clarification is not true. The auditing fails to help many persons
who rely on the audit report.
4. NO TRUE PICTURE: The auditing does not present cent percent true picture. The auditor is concerned
with figures shown in the books of accounts, Auditing fails to disclose true picture when figures have been
manipulated. The purpose of audit fails when it is unable to depict a real scene of business affairs.
5. NO CORRECT VIEW: Auditing fails to present correct view. There are limitations of accounting so
figures are not facts. These figures are based on opinion. Moreover, the auditor has to make judgments on
various matters. The personal judgments may be wrong in certain cases. Thus auditing is unable to disclose
correct view.
6. NO SUGGESTION: The audit is conducted to show a fair view of financial statements. Auditing is not
concerned with management policies. The auditor cannot guide management for better use of capital. The
auditor examines what has been done. He is unable to suggest what should have been done.
7. ABSENCE OF HONESTY: The auditing work depends upon various professional and personal qualities
of an auditor. Honesty and independence are highly essential traits. The auditor must certify which is true.
Management and other parties should not influence him. The absence of honesty and independence means
failure of audit purpose.
8. BIAS OF AUDITOR: The auditing fails to present fair examination due to the bias of an auditor. It is the
superiority of an auditor that he should be independent. The attitude of an auditor is included in audit work
when such quality is missing. The biased auditing fails to help many people.
9. HIGH COST: The audit work is completed with cost. ‘The cost of an audit should not exceed the cost of
errors and frauds, The small-scale business enterprises consider it as a burden on their performance.
Auditing fails to serve millions of business entities.
10. PAST ACTION: Auditing is nothing more than checking on past activities. It is not concerned with
present or future. The audit fee Increases the cost of the business concern.
 LIMITATION OF ACCOUNTING INFORMATION
Accounting information can be used to assist both financial and managerial oriented decisions. In order to come to
effective financial or managerial decisions, many factors other than accounting should be duly considered.

Accounting information is extremely vital in/and for all enterprises though it does have certain limitations.

I. Accounting is only one source of information and primarily provides information based on financial terms:
Although this information is vital, decisions cannot be based solely on a monetary basis. Various decisions depend
upon a diverse range of issues being considered. A unique combination of Quantitative as well as Qualitative factors
should be considered to ensure an effective decision making process.

II. The historical perspective of financial accounting: In order to obtain a recent estimate of an entity’s financial
performance, the corporate managers carefully scrutinize financial accounting information. In retrospect, this
information is based on past performance. The information does provide clarity on the monetary issues but does not
provide a definite insight into the strategic future; as the future holds various changes in terms of technology,
economic situations as well as political scenarios etc. Such factors in relation to accounting are unpredictable.
Therefore, a careful balance between historical accounting as well as the future forecasted outlook is required.

III. Historical cost accounting vs. underlying value in use: Some items loose their monetary value over a period of
time, but under the financial accounting rules need to be included in financial reports. Though mentioned year after
year in the books as monetary figures, the information may be unreliable due to the historical assumptions made on
the item’s measurability criterion. For example, a machine in a textile factory is considered to have a useful life
which extends over a period of ten years in monetary terms; however, after the period of ten years, the machine may
still have the same value as prior years and contribute significantly to the overall operability of the factory.

IV. Inability to reflect the true value of strategic management: Various factors such as goodwill and natural
circumstances influence the operations of an enterprise; however, these elements are difficult to measure thus,
leading to their unavoidable exclusion from financial reports. For example companies depend upon their
shareholders, who in turn depend on the performance of the Chief Executive Officers. Although the CEOs may have
been hired by the company based upon prior performance, their future performances are not reliably measurable as
they may continually vary. In the initial stages, it may be impossible to measure whether the CEO’s presence will
deter or appeal to the shareholders, which in turn will influence the profitability of the enterprise.

V. Measuring Volatility of external factors: Financial accounting information does not take into consideration
volatile and ever increasing changes in the natural and commercial environment. Although scarcely measurable in
monetary terms, their unstable nature may have adverse effects if included within the financial reports and have a
volatile and cosmetic impact upon the earnings of the firm. For example, tariffs on trade, duties and other
environmental issues can have significant short-term volatile effects on the organisation.

VI. The effect of non-stable monetary unit: Based from region to region, accounting information is generated at all
enterprises based on the assumption that the monetary unit is stable over a period of time. In the real world scenario,
the unit fluctuates on a daily basis. Enterprises usually decide on a flat rate to calculate their financing and investing
needs. However, this can have adverse impacts which cannot be communicated to shareholders, if the unit has high
fluctuations. For example: Indonesia 1995 US$ 1 = RP 6000, 1997 US$ 1 = RP 12000, 1999 US$ 1 = RP 9000.
(Figures are approximates, just to provide an insight into the argument about the effects of the fluctuations)
From the answer above, it is evident that certain limitations of accounting information have to be taken into
consideration before enterprises use merely financial information to aid their decision making process.

What are the challenges for ethics in business? Are they different for accountants?

Ethics is defined as that branch of philosophy concerned with the moral life and consisting of consideration of one’s
ordinary actions, judgments and justification as a means of discovering what one ought to do and of determining
what actions are morally good, acceptable, or right and what actions are unacceptable or wrong (Campbell, 1989).

A manager within an organisation always faces a conflict of interest between short term profitability and long term
sustainability of the entity. If the manager chooses to implement decisions that are beneficial to the entity in the long
term, his behaviour is primarily considered to be ethical. However, the goal of achieving short-term profit
maximization has been duly compromised. According to self-interest theory an individual seeks to maximize his/her
personal utility whereby short-term profit maximization motives could be thought dominate managerial incentives.

Ethicists have developed two frameworks relevant to businesses. They are the Utilitarian and Deontology
frameworks. Utilitarianism is defined as the moral correctness of an action based entirely on its consequences
whereas Deontology defines moral correctness of an action through the underlying nature of its correctness.
Deontology can be divided into two parts where one part considers that action itself is measured thus lying is always
unacceptable, on the other hand, the other part considers the cumulative nature of action as well as the consequences
and thereby deems that lying could be acceptable under certain circumstances.

Ethics within the scenario of businesses are largely determined by the frameworks outlined above. Business ethics
have a large impact upon the global society as fraud and embezzlement can impose large dead-weight losses within
the world economy. In Australia, business ethics are primarily defined by the Corporations Law and Accounting
Professional Codes Of Conduct such as the ICAA which govern the professional behaviour of the relevant
professional members.

Ethical rules for accountants are subtly more stringent than for normal business professionals. Under the assumption,
that the ethical behaviour of accountants mirrors the behaviour of the company auditors, I seek to explain the
underlying dilemma. The Chief Financial Officer works under the supervision of the Chief Executive Officer of the
organisation. His/her primary responsibility is to ensure that the financial reports prepared under his supervision
mirrors the true and fair view about the financial. operating and investing decisions of the entity. He is directly
accountable to the shareholders for his actions. However, his actions are determined by the leadership of the CEO. If
the CEO demands the CFO to incorrectly manipulate the financial reports of the organisation, the individual faces a
dilemma. He has a dual sense of responsibility and an ethical situation arises whereby, he/she can either pursue his
own self-interests (financial security) or disobey the commands of the CEO and report fairly to the share-holders.
Thereby, following the correct spirit of ethical behaviour, his role entails reporting fairly to the shareholders and
whistle blowing against the CEO.

Is there a conflict between self-interest and ethical behaviour?

In classical terms, self interest theory and ethical behaviour are deemed to have an eternal conflict. In accounting
literature this conflict is termed as “Compensation Plans”

The plan states that managers who have a short-term time horizon with an enterprise and have their bonuses based
upon the short-term profitability of the enterprise will be motivated to pursue their personal agendas (wealth) rather
than enhance the long-term sustainability of the enterprise. In deontology terms, there is a significant conflict of
interest in terms of the ethical behaviour of the manager which could be compromised by the self-interests of the
manager who might manipulate the true underlying profitability of the going-concern.