Question

(b) Discuss the purpose and limitation of a balance sheet.

Answer 1

The purpose and Limitation of Balance Sheet

Purpose:

i) To reveal the financial position of the company at a specific date

ii) The Balance Sheet shows what an entity owns (assets) and how much it owes (liabilities), as well as the amount invested in the business (equity)

iii) The current assets is compared to the current liabilities to estimate whether the company has access to sufficient funds in the short term to pay off its short-term obligations.

Limitations:

i) Balance sheets do not show true value of assets. Balance Sheet is recorded at historical cost and it may not reflect current market valuation.

ii) Some of the current assets are valued on an estimated basis, so the balance sheet is not in a position to reflect the true financial position of the business.

iii) The balance sheet can not reflect those assets which cannot be expressed in monetary terms, such as skill, intelligence, honesty, and loyalty of workers.