Introducing Financial Statements

Limitations of Financial Statements

Financial statements can be limited by intentional manipulation, differences in accounting methods, and a sole focus on economic measures. Some argue that financial statements are limited by inaccuracies due to intentional manipulation of figures, cross-time or cross-company comparison difficulties if statements are prepared with different accounting methods, and an incomplete record of a firm's economic prospects due to a sole focus on financial measures.

PHWC Statement of Financial Position, 2021 by Irvin Sto. Tomas

One limitation of financial statements is that they are open to human interpretation and error, sometimes even intentional manipulation of figures. In the United States, especially in the post-Enron era, there has been substantial concern about the accuracy of financial statements. High-profile cases in which management manipulated figures in financial statements to indicate inflated economic performance highlighted the need to review the effectiveness of accounting standards, auditing regulations, and corporate governance principles.

As a result, there has been a renewed focus on the objectivity and independence of auditing firms. An audit of the financial statements of a public company is usually required for investment, financing, and tax purposes, and these are usually performed by independent accountants or auditing firms and included in the annual report. Additionally, regarding corporate governance, managing officials like the CEO and CFO are personally liable for attesting that financial statements are not untrue or misleading, and making or certifying misleading financial statements exposes the people involved to substantial civil and criminal liability.

Another set of limitations of financial statements arises from different ways of accounting for activities across periods and companies. This can make it difficult to compare a company's finances across time or to compare finances across companies. Different countries have developed their accounting principles, making international comparisons of companies difficult. However, the Generally Accepted Accounting Principles (GAAP), a set of guidelines and rules, are one means by which uniformity and comparability between financial statements are improved. Recently, there has been a push toward standardizing accounting rules by the International Accounting Standards Board (IASB).

Another limit to financial statements as a window into the creditworthiness or investment attractiveness of an entity is that financial statements focus solely on financial measures of health. Even traditional investment analysis incorporates information outside financial statements to make organizational assessments. However, other methods, such as full cost accounting (FCA) or true cost accounting (TCA), argue that an organization's health cannot just be determined by its economic characteristics. Therefore, one must collect and present information about environmental, social, and economic costs and benefits (collectively known as the "triple bottom line") to evaluate accurately.