Wiley GAAP 2008

Concepts, Rules, and Examples

Limitations of a Balance Sheet

Although a balance sheet shows an enterprise's financial position at a point in time, it does not purport to report the value of the enterprise at that date. There are several reasons why this is so. One limitation of the balance sheet is that many assets and liabilities are reported at historical transaction prices (referred to as “historical cost”), that are used because they are objective and capable of being independently verified. Historical costs, however, will only equal fair value at the time of the actual transaction; thereafter, the two will almost always differ.

Many accountants and analysts believe that the balance sheet would be more useful if the assets were restated to reflect current values. These current values might or might not be market related, and might simply be presented as historical cost adjusted for the changing value of the dollar due to inflation. However, for some assets and liabilities, cost already closely approximates current fair value. The cost of monetary assets such as cash, short‐term investments, and receivables closely approximates their current fair values. The cost of current liabilities, which are liabilities that require either a current asset or another current liability to liquidate, is payable in a short period and closely approximates current values. If they were to be discounted to their present value, any discount amount would likely be immaterial because of the short ...