Chapter 5, Problem 5.1Q

What are the three limitations of the income statement?

To determine

To identify: The three limitations of the income statement.

Answer to Problem 5.1Q

The limitations of the income statement are the use of different accounting methods, judgment or estimates and record of only monetary activities.

Explanation of Solution

Income Statement:

It is one of the financial statements that lists the incomes and expenses of the business for an accounting year is called income statement. It is prepared at the end of the accounting period in order to know the profitability of the business.

Limitations:

• Different accounting methods report different results, therefore it can be used to manipulate the profit or loss amounts. For example: the use of FIFO (first in first out) method or LIFO (last in first out) method.
• Judgment or estimates are required while preparing income statement like the division of items of income and expenditure based on its nature.
• Only monetary items are represented by the income statement, while non-monetary items also play a major role to achieve the targets of the firm.

Conclusion

Thus, the use of different accounting methods, personal judgment or estimates and ignorance of non-monetary activities are some limitations of the income statement.