Accounting is about keeping track of transactions in financial records, categorising and presenting the transactions, and communicating the financial data to users.
Financial accounting is the area of accounting that does not take the amount of time that money is worth considering. Also, it does not show the value of money in the near future.
Let's say you've got ₹1000 today, and in 10 years, it is going to be more. Accounting systems for financials won't take this into their calculations when calculating the effect of how much the company's earnings are.
But, if you're looking at certain transactions or times in time, the value of money could be something to think about. For instance, if your business purchases something with credit now instead of cash over the next 10 years, cash will be more valuable as there's less risk of inflation over the course of time. Today, we'll go over the complexities of the limitations of accounting!
Did You Know?
Accounting information may not be accurate. Many of the information in account books are based on personal judgement, and accuracy cannot be guaranteed when assumptions are made based on personal opinions. The books of accounts do not always reflect the exact value of assets and liabilities.
Also Read: 3 Golden Rules of Accounting, Explained with Best Examples
What are Accounting Standards?
Accounting standards are an established set of standards, processes, and rules which define the base of accounting and financial guidelines and procedures. Accounting standards increase the disclosure of information about financials across every country.
Many countries employ International Financial Reporting Standards, and older International Accounting Standards developed and published by the International Accounting Standards Board. At present, there are 29 current IAS and 16 current IFRS standards, and these standards provide guidelines for handling various accounting relationships and transactions.
They are the basis on which the principles used in our daily accounting statements are based. With this knowledge of accounting standards, we can begin drawing some guidelines regarding how accounting regulations can be interpreted and how they impact those responsible for preparing financial statements.
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- Accounting isn't 100% accurate: Accounting records all financial transactions using the historical value. Accounting doesn't consider liabilities or assets' true value or market value.
- Accounting doesn't show the realisable value: The financial statements do not reveal the exact amount of assets. It shows the historical value of assets and depreciation that we presumed. However, the market value could be different from that of the balance sheet.
- Accounting ignores the qualitative element: Accounting records all financial transactions in the form of monetary transactions. However, accounting doesn't consider emotion and staff, relations, and public relations.
- Accounts can be manipulated: Accounting can be altered by manipulating the accounting system to avoid tax and demonstrate a better financial position for investors. It's as simple as adding a few entries to the journal that alter the company's actual position.
- Accounting does not consider the inflation rate: Accounting doesn't consider inflation rates. For instance, suppose we have a customer who needs to pay ₹1000. If he settles the amount in 5-6 months, the amount of ₹1000 may be reduced due to inflation.
- The company's privacy: The company's privacy cannot be guaranteed because we must present the financial statements to the public.
- Personal Biases: Accounting could be biased. For instance, selecting the depreciation rate can be influenced and could not be true.
Inflexibility and Rigidity
If you select one option, you are simultaneously excluding all other options. In the same way, when an accounting standard selects the method they prefer to use for the relationship or transaction, every other method of treating it is eliminated. It doesn't indicate that different methods are unsuitable or incorrect. However, it means that the selected method is the only option available to accountants.
The limitations of accounting standards lead to an inflexible and rigid accounting system. The issue arises from instances in which the accounting standard picks the method to treat a transaction which is not the best way. Even when the accounting industry realises that there is a suitable method, establishing or altering the accounting standard can be cumbersome and long.
It is a process that involves white papers and discussions before a standard is adopted, and it can take as long as 2 years. Then, an ineffective technique is used. The binding of accountants to unsuitable procedures due to inflexibility is the most important problem with accounting standards.
The Limitations of Accounting Standards
There are two approaches to looking at this issue of accounting standards. We've already talked about the necessity of changing accounting standards when required, which involves a lot of moving components.
There are high costs when creating accounting standards. It is estimated that the International Financial Reporting Standards program began in 2001, with its first standards, IFRS 1, being released in 2003. Up to date, sixteen standards have been published as IFRS in 19 years. It is worth noting that IFRS 1 was revamped in 2008 to reflect the findings that needed to be adjusted following the initial publication.
This process is expensive due to the time involved. The second reason for the limitations on the cost of financial statement preparation is evident in the compliance costs. In certain cases, accounting standards require a significant amount of responsibility on the shoulders of those who write financial statements. Accounting standards are becoming more specific in terms of keeping accurate information. However, they also place more burdens on accountants. The expense of getting estimates of these costs is huge since it requires the expertise of experts.
A lot of accounting standards provide options of accounting techniques accountants can employ. While this can go a long way in overcoming the drawbacks of accounting standards which are not flexible, it also introduces a new issue with accounting standards. It's the issue of choosing among the available options. When it comes to looking to value investment inventory, assets, and inflation accounting, among other variables, there are various methods that you can use. The problem this setback of accounting standards creates is that the different methods give different estimates for the same item most of the time.
This leads to a moral dilemma that could encourage accountants to select methods from different standards. This includes choosing methods that overstate income or assets in one standard while selecting methods that underestimate liabilities or expenses in a different standard. In the end, there could be overstating of the value and profit of the company. This issue with financial statements also hampers comparison of the financial data because two companies could choose to apply two different strategies to evaluate financial statements.
Also Read: What is Accounting Information?
How to Surmount the Limits
Accounting for financials has its share of drawbacks. But, there are easy ways to overcome these limitations to make the most of your financial accounting program.
1. The Value of Time for Money Is Not Considered
To allow this restriction to be overcome, it is crucial to evaluate the current worth of an investment against the projected value by evaluating the time frame between the present and the time when the investment is completed. In this way, you'll be able to decide whether it's worthwhile to invest in a specific project.
2. Different Companies May Use Different Methods of Depreciation
Although one method of depreciation might be more suitable for certain firms than the others, there's no limit to the variety of methods an organisation can use. This issue can be easily overridden by choosing an appropriate option for your business.
3. Smaller Businesses May Experience Issues With the Current System
It is feasible for small businesses to utilise the system currently in place if they are working with a finance professional who can input data right into their systems. So they don't need to calculate anything by themselves, and they can concentrate on what they enjoy doing in managing their business!
Conclusion
The drawbacks of financial accounting make it difficult to use. However, if you manage to overcome these limitations, you'll find this kind of accounting can benefit your business.
One option to circumvent these limitations is to hire an accountant skilled in dealing with these issues. Another alternative is to create an entirely new system that doesn't contain the limitations of this one. It could be an online account system or entirely switching to a different accounting system.
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