finance exam- limitations of financial reports

Question 1

why do financual reports possess limitations

Answer 1

don’t always give completely accurate representation of a business’s financial position.

Question 2

what are the 6 limitations of a financial report

Answer 2

1)normalised earnings
2)capitalising expenses
3)valuing assets
4)timing issues
5)debt repayments
6)notes to the financial statement

Question 3

what are normalised earnings

Answer 3

process of removing unusual influences such as special circumstances or economic upswings/downswings from the balance sheet to show the true earnings of a company. Purpose is to provide a more realistic assessment of the earning performance of a business.

Example : removal of a land sale, which would achieve a large capital gain but also distort the true earnings of the business.

Question 4

what is a capitalising expense

Answer 4

regarding a capital expense as an asset. which will not represent the true financial condition of the business as it undervalues and understates expenses.

Instead of including it as an expense on the income statement, it’s included as an asset on the balance sheet (e.g. new software system or research and development)

• This is to mislead shareholders or potential buyers of the company’s financial position.

Question 5

how is valuing assets a limitation

Answer 5

estimating market value of assets and liabilities

• It doesn’t truly represent worth of business assets as certain assets could have been purchased at a depreciated price- distorting accuracy of financial report
• Intangible assets are not recorded accurately

Question 6

how is timing issues a limitation of financial reports

Answer 6

reports usually cover a whole year so might not accurately show current position of business

• ASX are required to publish half yearly financial reports
  o allows for the manipulation of timing of transactions to mislead on a business financial position

for example, adding revenue of current reporting period into that of the previous or recording a current cost as being outside the financial year so it does not appear on the current reports.

Question 7

how are debt repayments a limitation

Answer 7

• Reporting debt finance on the balance sheet as historic cost & not presenting the debt repayments on revenue statement as an expense
• Some financial statements do not disclose specific info about nature of debt. E.g., when it is due or how long it has been outstanding.

Question 8

how are ntoes to the financial statement a limitation

Answer 8

info regarding accounting methods are left out of the financial reports.
* Normally at the end of finance report and includes additional details left out of main reporting docs