Financial statements prepared under historical accounting system suffer from a number of limitations, which are as follows:
1. No Consideration Of Price Level Changes
Financial statements prepared under historical cost accounting are merely statement of historical facts. Changes in the value of money as a result of changes in general level of price are not taken into account. Hence, they fail to give true and fair picture of the state of affairs of the organization.
2. Unrealistic Fixed Assets Values
In historical cost accounting, fixed assets are recorded and presented at the price at which they are acquired. Changes in the market value of such assets are ignored.
3. Insufficient Provision For Depreciation
Depreciation is a mechanism of generating funds to replace the fixed assets when the replacement becomes due. In historical cost accounting, depreciation is charged on the basis of historical cost of fixed assets, not at the price at which the same assets are acquired. The provision made by way of depreciation charge on the original cost will not be sufficient for the replacement of assets.
4. Unrealistic Profit
Income statement prepared under historical cost accounting does not reveal true profit. Revenues are recorded on current value basis whereas expenses are recorded at historical cost. Profits are over-stated during the period of inflation.
5. Mixing Up Of Holding And Operating Gain
In historical cost accounting, gain or loss on account of holding inventories may be mixed up with operating gain or losses. Holding gain or losses should be segregated from operating gain or losses to determine the true operating performance.
6. Fails To Present A Fair Value Of Financial Position
Balance sheet consists of monetary and non-monetary items. Monetary items like cash, loan, debtors, creditors etc. are shown at their current money value. Non-monetary items like inventory, building, land etc. are shown at historical costing, not at current value. During period of inflation, non-monetary items are understated. Thus, balance sheet fails to present a fair value financial position.
