Question

Discuss two limitations of financial statement analysis and discuss each limitation.

Answer 1

Two limitations of Financial Statements are:

1. No recording of intangible assets :​ Many a times, company creates an intellectual property but could not generate sales, which shows poor financial health on books. Not recording intangible assets on books  underestimate the value of a business, especially of one that has spent a large amount to build up a brand image or to develop new products.

2. Change in value : IUnder GAA, Fixed assets value of the company are not revalued to make changes as per the market value which can lead to misleading information if large part of the amount presented is based on historical costs. However, items like marketable securities are adjusted as per the market value. However this is set to change with IFRS.

3. Not always comparable across companies. If a user wants to compare the results of different companies, their financial statements are not always comparable, because the entities use different accounting practices. These issues can be located by examining the disclosures that accompany the financial statements.