What is the primary limitation of the balance sheet?

• A. It includes only cash transactions and excludes accruals.
• B. It reports assets and liabilities at historical cost, which may not reflect current market values.
• C. It is prepared on a quarterly basis only.
• D. It provides information only about a company's revenues and expenses.

Answer: (B)

Verified step by step guidance

1. Understand the purpose of the balance sheet: It is a financial statement that provides a snapshot of a company's financial position at a specific point in time, showing assets, liabilities, and equity.
2. Recognize the limitation of historical cost accounting: Assets and liabilities on the balance sheet are often reported at their historical cost, which is the original purchase price. This may not reflect their current market value, especially for items like property, equipment, or investments.
3. Consider the implications of historical cost: Reporting at historical cost can lead to discrepancies between the book value of assets and their actual market value, which may affect decision-making by investors and stakeholders.
4. Clarify what the balance sheet does not include: The balance sheet does not provide information about revenues and expenses (these are found in the income statement) or focus solely on cash transactions (it includes accruals as well).
5. Understand the reporting frequency: The balance sheet is not limited to quarterly preparation; it can be prepared at any interval, such as monthly, quarterly, or annually, depending on the company's needs.