Limitations of Balance Sheet
Balance sheet is the most important section of a complete set of financial statement. It gives vital information with regard to the ability of the entity to stay in business, furthermore it provides an insight into the financial status of the entity (Epstein, Nach& Bragg, 2007). However the balance sheet has limitations associated with the information it contains. The limitations can be situational dependent hence its effects can depend on various factors such as the degree of reliance placed solely on the document. The limitations of balance sheet are:
- It cannot provide all the information needed. Gauging the financial health of an entity doesn’t necessarily lean on the mere presentation of the balance sheet figures and items persie but a total scrutiny of various financial aspects and elements of the particular entity which cannot be deduced from the presentation of the balance sheet itself.
- It bases its information on the past and provides little help about the future.
- The statements of financial position values are reported based on the historical cost basis thus limit the ability to understand the current worth business.
- Lack of reporting and recording internally generated assets in the balance sheet which confines the whole projection of entity’s capability to generate cash and cash equivalents.
- The statement of the financial position depends on other financial statements and many of them are pulled from income statements. This pulling of the balance sheet information from other financial statements would bring forth propagation of these statements’ limitation into the balance sheet (Berry, 2010, p. 147).
- The reports on some of the elements are based on the aggregate basis where the notes to the financial statement might not give the whole and relevant information to know what is included in the figure report and what value is the item included in the total figure.
- Use of estimation is involved in reporting items which might not be appropriate and correct in terms of accuracy.
How the limitations can affect users of the balance sheet
It becomes almost impossible for the management of the particular entity to incorporate and report the effects of alternating socio-economic situations existing in the financial statements and hence the figures in the statement of the entity’s financial position might not be the correct representation within particular set of conditions surrounding the entity (Lee, 2006). This is a crucial concern in the case where the entity operates in an economically and politically volatile environment.
It does not also give the user a position to reflect the true financial position of the business due its estimated basis on the current assets for instance intangible assets like goodwill are shown at imaginary figure, which might not allow any relationship to the market value.
According to Stolowy&Lebas (2007), the various items reported in the balance sheet entail the use of estimation which may not be appropriate and the user may be interested in understanding how the particular estimates came about and the level of relevance of such estimates after the publication of the financial statements.