4.8 Limitations of published accounts

Question 1

What are the problems associated with using the “historical cost” measurement?

Answer 1

It fails to account for the change in price levels over time, meaning that value is often overestimated.

Question 2

What is creative accounting?

Answer 2

Presentation of the accounts in the most favourable way possible.

Question 3

What are the problems associated with intra-group transactions?

Answer 3

There is a bias involved in dealing with subsidiaries and directors or their families. Therefore transactions may not have been carried out in the best interests of the entity itself.

Question 4

Certain maters cannot be measured in fincancial terms (i.e. non-financial matters). Why can this be problematic?

Answer 4

These matters do not form part of the financial statements, but may provide important context. e.g. a business may be reporting excellent results, but actually have a very weak reputation.

Question 5

Accounts are often criticised as being not “forward-looking”. Why is this problematic?

Answer 5

Accounts based on historical information do not account for future challenges and therefore make it difficult for investors to make informed decisions.

Question 6

What is “seasonality of trading” and why is it problematic?

Answer 6

Entity’s who usually trade during a certain time of the year will often report when they are most solvent, distorting results.

Question 7

Why are the accounts of different entities often incomparable?

Answer 7

Different entities may use different accounting techniques.

Question 8

Financial statements only cover a certain time period. Why is this problematic?

Answer 8

An entity can distort its results by taking actions just within the end of the year .