Global Journal of Management and Business Research, A: Administration and Management, Volume 22 Issue 8

Inherent limitations of financial reporting that, as such, cannot be overcome In addressing the issue of the so-called 'inherent limitations of financial reporting, it is appropriate to recall two peculiarities of financial reporting that, although they may be considered potential limitations, are inherent to financial reporting itself and, consequently, must be interpreted, not as 'shortcomings or limitations of the financial statements, but rather as elements characterising that document. The two distinctive elements of financial reporting mentioned above can be summarised as follows: 1. Since management is characterised by what is commonly called economic unity, financial reporting breaks down into annual periods, which is, by its nature, indivisible. While the company's total income (i.e. the income produced from the beginning of the company's life until its liquidation) is an objective value, the profit/loss and capital determined at the end of each administrative period, due to the presence of estimated quantities (i.e. approximations to the 'true'), and conjectured values (i.e. subjective representations of the 'true'), identify aggregates lacking an objective 'absolute truth'. For this reason, concerning financial reporting, instead of speaking of 'truth', the terms 'reliability' or 'veracity' of accounting values are used. This intrinsic feature of financial statements, identifying an element inherent in the balance sheet and profit and loss, cannot, however, be counted among the informational limitations of this document as it identifies 2. Another distinctive element of financial reporting concerns the type of data recorded therein: the accounting values recorded in the balance sheet and the profit and loss are actual quantities, although the presence of forecast aspects also characterises them. This is a direct consequence of the presence, in the balance sheet, of subjective values, the determination of which depends, not on a mere ascertainment of facts that are now past and concluded, but on an estimation/planning of future events. Consider, for example, the determination of depreciation. The annual depreciation charged to the financial year also depends on considerations regarding the future use of the long-term asset. Similar considerations can be developed concerning quantifying all provisions for future liabilities and charges. Even though the determination of balance sheet and profit and loss accounting values implies the consideration of future events, there is no doubt that the documents constituting financial reporting for the year are of a consumptive nature. Although the assessment of creditworthiness cannot disregard the analysis of the company's prospects, the final aspect of financial reporting does not bring this element within the so-called "disclosure limits of financial statements". The circumstance that the values recorded in the balance sheet and the profit and loss are data referring to the closing date of the financial year rather than a limitation represents, therefore, a distinctive trait of financial reporting that, as such, must be accepted and, consequently, interpreted not as a shortcoming but as an intrinsic requirement of such a document. Concerning the undoubted interest that every user external to the company (shareholders, employees, the community, scholars, etc.) has in information regarding the company's prospects, it must be emphasised that Article 2428, paragraph 3 of the Italian Civil Code establishes that, in any case, the management report must include information on the foreseeable evolution of operations. This specific point will be further discussed in the following pages. Disclosure limitations resulting from accounting behaviour that does not fully adhere to correct financial statement postulates The list of 'limitations' of financial reporting, understood as a tool for assessing creditworthiness, may include so-called 'information limitations arising from the application of accounting behaviour that does not perfectly adhere to correct financial statement postulates'. For obvious reasons, we do not intend to refer to the hypothesis that, voluntarily, the accounting data are distorted by false disclosures of objective values implemented to carry out unlawful balance sheet policies. Regardless of the objectives of manipulating financial statement data, implementing such operations renders the balance sheet, profit and loss, report of the notes to financial statement report on operations, and documents devoid of any informative consistency. Of little relevance for our analysis appears the consideration of the informative consequences on the determination of the company's creditworthiness, deriving, for example, from the inclusion in the accounts of incorrect objective values as the result of not recording revenues or balance sheet items, the recording of inexistent costs; the recording of assets that do not exist in the company; etc. In this case, however, it seems inappropriate to include such a hypothesis among the "limits" of financial reporting, since the desire to communicate a company condition that is different from the "real" one by falsifying the accounting values does not appear to be an informative limitation of the financial statements, but rather a fraudulent practice that, like any other operation carried out to mislead third parties, renders financial reporting invalid and, in the cases provided for by Article 2621 of Financial Reporting Destined to External Third Parties as a Tool for Analyzing Credit Worthiness: Usefulness and Limitations. The Italian Case 70 Global Journal of Management and Business Research Volume XXII Issue VIII Version I Year 2022 ( ) A © 2022 Global Journals