Valuing assest, Debt repayments and Timing issues
Hey justdoit!
So limitations on financial reports are issues that you should be aware about that can distort the true figures or give a more accurate representation of a business' position.
Valuing assets:
Valuing assets is a limitation to financial reports/statements. This is because it is sometimes hard to estimate how much an asset is worth - creating inaccuracies.
Sometimes, assets are recorded using its historical cost or cost when the asset was purchased. This becomes an inaccurate representation of the assets worth over time as depreciation occurs, in which the value of the asset decreasing over time as it becomes obsolete. If the historical cost is used on a balance sheet for example a year after it was purchased, this would distort and overstate the value of total asset. - thus limitation to financial resources as it is prone to inaccuracies.
Note - this also occurs when non-current assets like land appreciate.
This is also a limitation since intangible assets such as goodwill, patents, brand names which are listed on balance sheets are hard to calculate since there is no monetary value attached to them. Thus the valuing of assets can be overstated or understated = limitation of financial reports since it may be inaccurate or misleading.
Debt repayments:
Any form of debt or liability primarily on balance sheet (can be P&L or cash flow) is normally considered bad. However, in order to make an informed judgement over the business' solvency, we need to know things like:
- How long the business has had the debt
- Capacity of the business to pay it's debt
- Adequacy of provisions or methods the business has for recovery of debt
- Provisions in place for doubtful debts
- Debt repayments under another financial period
- When the debts are due - monthly repayments
E.G A loan of $5000 on a balance sheet might seem bad, but if the repayments are only $20 a month and the business earns $2000 in sales a month; then it doesn't seem like a large amount and won't affect liquidity that much.
Timing Issues:
This revolves around the "matching principle" in which whenever revenue is recorded, there should be matching expenses for that revenue. I.e. any profit generated should have a cost associated - $500 in sales should be attributed to some sort of cost in buying the products.
This especially becomes an issue when the cost is recorded in the previous financial year, but the product is sold in the following year - this causes an understatement of profits in the first year and hence lower tax paid. This becomes a major issue if this practice were
widespread in a business where sales were hundreds of millions a year. inflows of cash and the payment of debt can be easily manipulated in financial reports. Thus, most large businesses publish six-monthly reports so that the potential to mislead needs to be carefully considered.
Note that this practice can be used for any kind of income or cost including long service leave, holiday payments etc.
Also, Deng has an excellent explanation on the difference between mentoring and coaching above
Hope this clears things up!!