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ACCA Applied Skills · Financial Reporting · Limitations of financial statements

Which of the following is a recognised limitation of relying on a single entity's historical-cost financial statements when assessing its current financial position?

Historical-cost statements can understate net assets because assets such as property are held at depreciated cost rather than current value, especially when prices rise. This limits their usefulness for judging current financial position, whereas IFRS statements use accruals rather than cash accounting.

  1. ANon-current assets may be carried at amounts well below their current market values, so net assets may be understatedCorrect
  2. BFinancial statements are always prepared on a cash basis, so profit is unreliable
  3. CHistorical-cost statements include unrealised gains on all assets, overstating equity
  4. DFinancial statements are not required to comply with any accounting standards

Explanation

Under historical cost, assets such as property are held at cost less depreciation, so in periods of rising prices carrying amounts can be well below current values. The cash-basis option is wrong because IFRS financial statements use the accrual basis. Unrealised gains are not generally recognised under historical cost.

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