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Basics of Cost Accounting - 2: Limitations of Financial Accounting

Limitations of Financial Accounting

        Financial Accounting is mainly concerned with recording of business transactions. It provide the information to internal and external parties. Managers, departmental heads, management are the examples of internal parties. Investors, shareholders, debtors, government authorities, banks are the examples of external parties.

1. Shows overall performance: Financial accounting presents an overall picture of a company's financial health through financial statements. However, it lacks granularity in detailing specific operational areas or segments of the business, which might be essential for internal decision-making.

2. Historical in nature: Financial accounting records and reports past transactions. It provides information on what has already occurred but may not accurately reflect current market conditions or predict future trends. This historical data may not always be suitable for making forward-looking decisions.

3. No proper performance appraisal: Financial accounting focuses on monetary transactions and doesn't offer detailed insights into non-financial aspects crucial for performance appraisal, such as employee morale, customer satisfaction, or operational efficiency.

4. No material control: Financial accounting may not effectively monitor and control the usage of raw materials or other resources in the production process, leading to inefficiencies or wastage that impact profitability.

5. No labor cost control: Similarly, while financial accounting records labor costs, it might not provide detailed insights or tools for effectively controlling or optimizing these costs, such as improving productivity or managing overtime expenses.

6. No proper classification of cost: Financial accounting might lack the detailed classification needed for internal decision-making. It might bundle costs into broad categories in financial statements, making it challenging to identify specific costs associated with different products, departments, or activities.

7. No cost comparison: Financial accounting may not provide detailed cost comparisons across different periods, products, or divisions, which are crucial for identifying trends, cost-saving opportunities, or areas needing improvement.

8. Fails to supply information to the management: Financial accounting focuses on external reporting requirements and might not always provide management with the timely, detailed, or relevant information needed for day-to-day operations or strategic decision-making.

9. No Break Even Point: Financial accounting doesn't explicitly calculate or present the break-even point, which is crucial for managers to determine the level of sales needed to cover all costs, making informed pricing or production decisions.

        To address these limitations, companies often supplement financial accounting with cost accounting techniques. cost accounting focuses on internal reporting, providing detailed information for decision-making, planning, control, and performance evaluation, filling the gaps left by financial accounting's limitations.

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