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Limitations of historical Accounting

LIMITATIONS OF HISTORICAL ACCOUNTING

 

The following are the important limitations of historical accounts.

 

(i)   In actual practice the financial statements are prepared on the basis of the  historical cost. So  the financial statements may be incorrectly interpreted unless appropriate adjustment are made on the current price level.

 

(ii) Unrealistic profit due to the depreciation calculated under the historical cost method

 

(iii) Insufficient provisions of depreciations

 

(iv) According to Companies Act 1956 fixed assets are shown at their historical cost and not at current cost.

 

(v) Return on capital employed is misleading because the profits are overstated and fixed assets are understated.

 

(vi) Incorrect ascertainment of operating capacity

 

(vii) Historical cost accounting mixes up the holding gains and its operating gains which does not help in taking effective managerial decisions.

 

(viii) Misleading inter-period and inter-firm comparison

 

(ix) Difficulty in comparison of profitability of two plants

 

To overcome the limitations of conventional accounting, accounting for price level changes is developed or advocated.

 

Accounting for changing prices (or inflation accounting) is a system of accounting

which regularly records all items in financial statements at their current values.