1.

WHAT ARE THE LIMITATIONS OF ACCOUNTING

PRINCIPLES

Accounting principles are general decision

rules derived from the accounting concepts.
According to AICPA (US), a principle means,
“a general law or rule adopted or professed
as a guide to action: to settled ground or
basis of conduct or practice.” Accounting
principles are characterised as ‘how to apply’
concepts.
THE LIMITATIONS OF ACCOUNTING
PRINCIPLES
Accounting Entity Principle

Financial reports are produced for the business, independent of the owners – the
business and its owners are separate entities. This is particularly important for owner-
managed businesses where the personal finance of the owner must be separated from
the business finances. The problem caused by the entity principle is that complex
organizational structures are not always clearly identifiable as an ‘entity’. The treatment
by Enron of joint-venture vehicles that were not part of the “Enron group” for financial
reporting purposes enabled ‘off-Balance Sheet’ financing that was a cause of that
company’s collapse.

Accounting Period Principle

Financial information is produced for a financial year. The period is arbitrary and has no
relationship with business cycles. Businesses typically end their financial year at the end
of a calendar or national fiscal year. The business cycle is more important than the
financial year.

Monetary Measurement Principle

Despite the importance of market, human, technological and environmental

factors,accounting records transactions and reports information in financial terms. This
provides a limited though important perspective on business performance. The criticism
of accounting numbers is that they are lagging indicators of performance. An emphasis
on financial numbers tends to overlook important issues of customer satisfaction,
product/service quality, innovation and employee morale, which have a major impact on
business performance.
Going Concern Principle

The financial statements are prepared on the basis that the business will continue in
operation. Many businesses have failed soon after their financial reports have been
prepared on a going concern basis, making the asset values in the Balance Sheet
impossible to realize. As asset values after the liquidation of a business are unlikely to
equal historic cost, the continued operation of a business is an important assumption.

Conservatism Principle

Accounting is a prudent practice, in which the sometimes over-optimistic opinions of

non-financial managers are discounted. A conservative approach tends to recognize the
downside of events rather than the upside.

Disclosure Principle

The accounting standards and principles that have been applied in the financial
statements are described in the financial reports. It is interesting to know that in the
UK, there is a substantial body of principles governing what information is to be
disclosed in financial reports, although in the US the disclosure requirements are rule
based rather than principle based. As a result, it has been argued that it is easier to find
ways to get around rules that are set in explicit terms than principles that are more
general.

Consistency Principle

The cost that is calculated under these assumptions may have limited decision
usefulness.

Cost Terms and Concepts

Accountants define costs in monetary terms, and while we will focus on monetary costs,
readers should recognize that there are not only non-financial measures of performance
but also human, social and environmental costs. The exclusion of human, social and
environmental costs is a significant limitation of accounting.

This are the limitations of different Accounting

Principles.
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Contributor: Shikha Saraf (Section-C)