In the context of a classified balance sheet, what is the primary limitation of the balance sheet?

• A. Many assets and liabilities are reported at historical cost, which may differ significantly from current fair values.
• B. It provides detailed information about the timing and amounts of cash inflows and outflows during the period.
• C. It guarantees that all economically valuable resources of the company (including internally generated intangibles) are recognized and measured objectively.
• D. It reports the company’s results of operations (revenues and expenses) for the period.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the purpose of a classified balance sheet. It organizes assets and liabilities into current and non-current categories, providing a snapshot of a company's financial position at a specific point in time.
2. Step 2: Recognize that the balance sheet primarily reports assets, liabilities, and equity based on historical cost, which is the original transaction value recorded when the asset or liability was acquired or incurred.
3. Step 3: Identify the limitation that arises because historical cost may not reflect the current fair market value of assets and liabilities, leading to potential discrepancies between reported values and actual economic worth.
4. Step 4: Note that while the balance sheet provides valuable information about financial position, it does not guarantee recognition or objective measurement of all economically valuable resources, such as internally generated intangible assets.
5. Step 5: Differentiate the balance sheet from other financial statements: it does not report cash inflows and outflows (which is the cash flow statement) nor the results of operations (which is the income statement).