Limitations of Financial Reports

Limitations of Financial Reports – normalised earnings, capitalising expenses, valuing assets, timing issues, debt repayments, notes to the financial statements

Limitations of financial reports

  • Income statement may not give a clear picture of the businesses profitability
  • Complicated and detailed accounts will confuse individuals who do not have a background in accounting

Normalised Earnings

  • The earnings adjusted to take into account cyclical upswings or downswings in the economy, or to remove one-time influences
  • A large one-time gain or loss would dramatically affect a business’s profit or loss for a given period and would need to be taken into account and adjusted for.

Capitalising Expenses

  • The costs incurred when financing a non-current asset and added to the cost of the asset. For example: the purchase of a property would involve payment for legal fees and stamp duty
  • When placed in the accounting framework these expenses are capitalised (i.e. added to the cost of the assets).

Valuing Assets

  • Original cost of an asset on the balance sheet is different from its market value
  • Value of asset on balance sheet is always changing. Revalue through external assessors.
  • Some assets will appreciate over time (for example, real estate) and some will depreciate over time (for example, tools or vehicles)
  • Intangible assets are of value to a business but do not physically exist. Patents, trademarks and brand names.

Timing Issues

  • Accountants may adjust the timing of revenue inflows and debt repayments to make business appear profitable
  • Business can hold off a large expense or revenue being recorded so it does not show up in the current accounting period
  • Delay banking revenue until the start of a new financial year in order to decrease the business’s current taxation commitment
  • They can delay an expense and incur a tax liability for the following year

Debt Repayments

  • Business needs to set aside funds to provide employees with payment for holidays, entitled leave. It is difficult to determine exactly when a payment for entitled leave will be required.
  • Money owed to the business may not be accurately recorded

Notes to the financial statements

  • Additional information normally at the end of financial reports
  • Notes provide additional information and details about items included in the balance sheet and income statement
  • They may not be clear, explicit or not detailed enough


Extract from Business Studies Stage 6 Syllabus. © 2010 Board of Studies NSW.