Limitations of Financial Reports

Question 1

Normalised earnings

Answer 1

Where one-off transactions in the income statement distort profits - ‘profit or loss on a sale of a non-current asset’ (factory or vehicle)

Question 2

Capitalising expenses

Answer 2

Where expenses are put on the balance sheet not in the income statement, making assets and profits overstated (R&D or other ‘costs’ or ‘expenses’ are IN ASSETS)

Question 3

Valuing assets

Answer 3

Where assets a re valued subjectively e.g. goodwill, or revalued to market value/cost

Question 4

Timing issues

Answer 4

Where transaction are not recorded in the correct financial period income statement e.g. accounts receivable sales need to be recorded when transaction happens not when business is paid.

Question 5

Debt repayments

Answer 5

Where the repayment date of debt is unclear

Question 6

Notes

Answer 6

Where an investor can find out information about any limitations to the financial statements

Question 7

Ethical issues related to financial reports

Answer 7

Where:
- Businesses use limitations of financial statements to distort profits
- Businesses buy other companies then sell off the assets to generate cash (asset stripping)
- Financial statements mislead investors