limitations of financial reports

TODO limitations of financial reports notes 📅 2024-03-08
Limitations refer to the shortcomings of accuracy in disclosed financial reports
- each limitation are opportunities for ambiguity
- to which businesses can present their financial situation as better off

Normalised earnings are :: the earnings that have been adjusted to take into account changes in the economic cycle or to remove one-off items that may distort profitability such as the sale of land.
makes it easier to compare profitability figures from different years and against other businesses.

Capitalising expenses is :: an accounting method where a business records an expense as an asset on the balance sheet rather than an expense on the income statement.
- where expenses are regarded as a capital item and put into the balance sheet rather than the P&L
- e.g. a business spends $30m on Research and development
  - which produces a patent valued at $25m
  - hence the $25m patent is placed on the balance sheet as an asset
  - and the -$5m difference (loss) is recorded on the income statement. (where it originally belongs)

Valuing assets is : the process of estimating the value of assets when recording them on a balance sheet.
Valuing assets can be difficult, the asset may be recorded at its historical cost
- where assets are listed with their value at the time of purchase
additionally it can be difficult to value intangible assets, such as:
- goodwill
- trademarks
- patents
- brand names

The matching principle is a fundamental accounting concept
The matching principle states
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that expenses incurred by a business must be recorded on the income statement for the accounting period in which the revenue is earned.
- (i.e. the costs associated with generating revenue from a certain source should be reported adjacent to the said revenue to give a more accurate picture)
  - even if the costs were a financial period before
e.g. a house is sold (in June), but the money is not paid until months later (August)
- The expense should be recorded in June

Debt repayments refers to : either the money owed to the business or by the business.
The gearing ratio determines whether a business is at risk of meeting long-term financial obligations.
- fluctuations in gearing affect risk and potential profits
financial reports are limited as they do not have the capacity to disclose specific information about debt repayments.
- sometimes debt repayments can be used to distort the reality of the businesses financial status

The notes to the financial statements include any additional information that is left out of the main financial reporting statements.
contains info useful to stakeholders to make sense of financial statements, for example, extra info on;
- the accounting methodologies,
- inventory valuation techniques

🪴 JoshNotes