Objectives and Limitations of Accounting

Objectives of Accounting:

To maintain full, systematic and permanent records of business transactions:

  • Accounting is the language of business transactions. Accounting is done to keep a systematic record of financial transactions.  The main objective of accounting is to maintain ‘a full and systematic record of all business transactions for current and future references It saves human memory from overburden.
  • These records are useful for the internal purpose, for taxation purpose or for any other purpose. These permanent records help the firm to understand the trend in the business and make decisions.

To ascertain profit or loss of the business:

  • The main objective of any business firm is to earn a profit.  Business firms perform many transactions. Some of them are profitable while some may incur a loss. Profit & Loss Account gives an aggregate idea of these transactions and presents the financial performance of the firm for the period. The comparison of income and expenditure gives either profit or loss.

To present financial position of the firm:

  • At the end of the period balance sheet gives the financial position of the firm on that date. The balance sheet shows assets and liabilities of the firm. Thus balance sheet shows the financial health of the firm.

To help top management to make decisions:

  • Accounting through the collection, analysis and reporting provide information at the required points of time to the required levels of authority. A useful and sensitive information is available for internal users like top management and board of directors. It helps them to take a rational decision.

To project creditworthiness of the firm:

  • Investors will invest or lenders will lend money to the firm only if they have reasonable assurance that the firm will be able to generate enough profit to service the debt. There are various parties who are interested in accounting information of the firm. These include bankers, creditors, tax authorities, prospective investors, researchers, stock exchanges, etc. Hence, Accounting provides the required information available in the form of an annual report to these interested parties to enable them to take sound and realistic decisions.

To use resources effectively:

  • Accounting records tell the firm what resources were committed to what activity and at what time. Accounts give information about the return that was obtained from these activities. Using the data from accounts effective control can be obtained and effective use of resources is achieved.

To comply government requirements:

  • In case of limited companies, the reporting financial information to shareholders, Registrar of companies and Security and exchange board of India is mandatory. Accounting helps the firm to comply these legal requirements.

To calculate taxable income:

  • Using financial accounts the taxable income for the period can be calculated.

Users of Financial Statement:

  • Accounting information helps users to make better financial decisions. Users of financial information may be both internal and external to the organization.

Internal users (Primary Users):

  • Internal users of accounting information are those persons or groups which are within the organization. Accounting information is presented to internal users usually in the form of management accounts, budgets, forecasts and financial statements.
  • Management:  The accounts are the basis; the management to understand the progress of the firm. Accounts project financial health of the firm. Using which management can take strategic, operational decisions by studying the trend. If required some corrective measures are taken by the management. It also helps the management in cost control.
  • Owners: The owners provide funds or capital for the organization. Accounts show viability, profitability and return on the investment made by the owners of the firm. It helps them in assessing the taxes, the goodwill of the firm and in determining the future course of action.
  • Employees: It helps the employee to assess company’s profitability and credential. The demand for the wage rise, bonus, post-retirement benefits, stock options, better working conditions etc. depend upon the profitability of the firm which depends upon the financial position of the firm. From accounts, they can foresee their future remuneration and job security.

External users (Secondary Users):

  • External users are those groups or persons who are outside the organization for whom accounting function is performed.
  • Creditors: Using accounts determining the creditworthiness of the firm can be assessed. Accounts show repayment history and capacity of the firm. Creditors include suppliers supplying goods on credit, lenders, banks, etc. Terms of credit and its approval depend on the financial health of the firm. Profit and Loss Account and Balance Sheet gives an idea of the financial health of the firm to creditors.
  • Government and Tax Authorities:  Tax authorities and government are interested in the financial statements to know the earnings of the firm for the purpose of taxation. To calculate GDP, various indices and to prepare budgets and policies this information is important for government. It helps tax authorities to check the credibility of the tax returns filed on behalf of the firm. The government can also check about monopolies, cartel formation and take effective action.
  • Investors: Investors want to make sure they can earn a reasonable return on their investment before they commit any financial resources to the company.  Hence they invest money in a firm with good financial performance. They can take the decision of investment by going through the financial statements of the firm. The stock prices of the firm on stock exchanges depend on their financial performance and policy of disbursement of profit.
  • Customers: Consumers are interested in good products at low price with good after-sales service. A good accounting and cost control can reduce the cost of the product. Companies financial health assures consumer of stable, continuous supply of products, warranty obligations, services and spare parts.
  • Regulatory Authorities: Regulatory authority like Registrar of the Companies are interested in the company’s disclosure of accounting information. They want to ensure that it is in accordance with the rules and regulations set in order to protect the interests of the stakeholders.
  • Research Scholars: Financial information of the firm is useful for research scholar who wants to make a study into the financial operations of a particular firm.

Limitations of Financial Statements:

No qualitative approach:

  • Only transactions that can be measured in terms of monetary unit are covered in financial accounting. Thus only quantitative information is included in the financial statements. it fails to explain qualitative information such as management labour relations, customer’s satisfaction, management’s skills, leadership, human relations, product quality, research & development, brand image, etc.which are also equally important for decision making.

Historical in Nature:

  • Financial statements are calculated on the basis of historical cost. Thus it does not carry the real value of the asset but shows original cost less accumulated depreciation. Hence, historical information has little scope for decision making. The real position of a firm changes day by day.
  • Various assets and liabilities are recorded in the balance sheet at their book value and not real value. Hence, ithe financial position of the company cannot be judged from the balance sheet.

Incomplete Information:

  • The financial statements are prepared for an accounting period. Hence, they are estimated and not accurate. The exact financial position of the business can only be determined when it is closed down.

Can be Misleading:

  • The accuracy of financial information largely depends on how accurately financial information is collected and how accurately the financial statements are prepared.The analysis of wrong financial statements will also be wrong which may mislead the user in making a decision.

Do not consider Social and Political Factor:

  • The financial position of a business is affected by economic, social, cultural and financial. The financial statements include only financial factors.  Firms are greatly affected by economic, social, cultural factors. A change in these factors may affect the firm to large extent.

Non Comparable:

  • Different companies adopt different accounting policies. and hence their financial statements differs from one company to another. Hence, the financial statements of two companies cannot be compared. The government now made it mandatory to have same accounting practices.

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