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Advantages and Limitations of Accounting

Advantages & Limitations of Accounting - Success Roar Classes

What are the advantages or uses of accounting?

  1. Helpful in Management of business-
    1. The accounting provides the management various information in the form of internal reports, Financial statements, etc. which helps them in performing the following functions-
      •  Planning– The information regarding increase or decrease in sales, purchases, expenses, etc. helps the management to make a future plan or budget, estimate future earnings and expenses, making strategies for expansion, etc.
      • Decision making- The accounting information helps management to make various decisions like making new investments, purchase of fixed assets, launching new products, etc.
      •  Controlling– Accounting information provides management the various information regarding the overspending on any department or process, wastages, losses, etc.
      • On the basis of this information, Management can implement various control procedures to reduce these losses. (Advantages and Limitations of Accounting)
  2. Provides Complete and Systematic Record
    • Due to numerous transactions in any business, it is impossible to remember these transactions and make any conclusion regarding the profitability and financial position of the business.
    • Accounting helps to maintain a complete and systematic record and summarizes all the transactions of the business and provides a summarised information regarding the profitability, growth, and financial position of the business.
  3. Information Regarding Profit or Loss
    • With the help of the Profit & Loss Account, a user can easily identify the net profit or loss of the business during the year.
    • The Profit & Loss Account provides the details about the various income and expenses of the business. (Advantages and Limitations of Accounting)
    • With the comparison among Profit & Loss Account for two or more years, a person can easily identify the trend of the business profit.
  4. Information Regarding Financial Position
    • By preparing a Balance Sheet at the end of each accounting period, accounting provides information about the financial position of the business.
    • A Balance Sheet contains the information regarding the assets and liabilities and their values on a specific date which represents the financial strongness of the business entity.
  5. Helps in Comparative Study
    • Accounting is done for each accounting period.
    • Hence a comparison can be done for expenses, incomes, losses, etc, with the help of the financial information of two or more years.
    •  These types of comparisons provide useful information for taking various decisions by the management, employees, investors, etc.
  6. Evidence in Legal Matter
    • Systematic and complete accounting records supported by the authenticated documents can be presented in the courts as evidence.
  7. Helpful in Raising Loans
    • The banks and various financial institutions require financial statements and other accounting information for example fund flow statement, cash flow statements, etc. while providing any kind of loan or credit facility.
  8. Helpful in Partnership Accounts
    • In the case of the partnership business, accounting records provide various information required at the time of admission, retirement, or death of a partner, etc.
    • Various accounting treatments for example accounting treatment for Goodwill, revaluation of assets and liabilities are done based on the accounting records.
  9. Prevention and Detection of Errors and Frauds.
    • Accounting records provide complete and systematic records of assets and various other resources of the business.
    • This helps the management to implement various control procedures and to reduce the possibilities of errors and fraud in the business.

What are the limitations of accounting?

  1. Influenced by Personal Judgements
    • While doing accounting an accountant needs to use his personal judgment in respect of various items. For example, deciding the useful life of any fixed assets, estimation regarding doubtful debts, deciding the method of stock valuation to be used, etc.
    • All these judgments have an impact on the financial information provided by accounting. In case of any wrong estimation or judgment, the accounting records will not provide an accurate picture of the business operations.
    • Further, these personal judgments differ from person to person hence the accounting record cannot provide exact figures related to profit or loss, the value of assets, etc.
  2.  Based on Accounting Concepts and Conventions
    • The accounting records are prepared on the basis of various accounting concepts and conventions. Therefore, the profitability and the financial position disclosed by it may not be realistic.
    • For example, the conservatism concept of accounting provides to record future losses but ignores the future incomes, hence the profit of the business may not show the exact figure of profit.
  3. Ignorance of Qualitative Information
    • The accounting records only those transactions which can be expressed in terms of money.
    • There are various qualitative aspects like the efficiency of management, hard work of employees, customer satisfaction, etc. which are very crucial for business growth but ignored while doing accounting.
  4. Based on historical cost
    • The accounting records are based on historical cost means the cost incurred in past on various items. It doesn’t show the changes in the current price level.
    • Hence various times the financial information does not provide a correct picture of the assets, liabilities, profits, etc. of the business.
  5. Affected by Window Dressing
    • Window dressing means manipulating the accounts to represent the desired results. For example, the amount of sale of goods on approval on which approval is not received from the customer added in the amount of sale, overvaluation of assets, etc.
    • In this case, the accounting records will not represent the actual position of the business.
  6. Not suitable for forecasting or future assessment
    • Forecasting means predicting the future income, expenses, and financial position of the business.
    • The forecasting is done on the basis of accounting records which are based on the historical cost, past market situation, etc. Hence these may not be useful in forecasting. (Advantages and Limitations of Accounting)

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