Table of Contents Hide
- What is Periodicity Assumption?
- Why Does the Company Use a Different Fiscal Year?
- The Importance of Periodicity Assumption
- Periodicity Assumption Example
- The Benefits of the Periodicity Assumption
- The Periodicity Assumption’s Drawbacks
- Periodicity Assumption FAQs
- Which accounting principle relates to the periodicity assumption?
- How does the periodicity assumption affect an accountant's analysis of accounting transactions?
- What is the purpose of examining and analyzing trends in a company's financial ratios and other data?
The periodicity assumption implies that a company’s economic activity may be separated into relevant reporting periods. Periodicity in accounting refers to the assumption that a company’s complex and ongoing activities may be split up and reported in yearly, quarterly, and monthly financial statements. Let’s look at the significance of the periodicity assumption, an example, the benefits and drawbacks, and how you may use them in your organization.
What is Periodicity Assumption?
The periodicity assumption states that a company’s economic activity may be separated into relevant reporting periods. Because of government, internal management, shareholders, and other regulations, each company may have a separate financial period. It is also known as the fiscal year of the company.
The calendar year (which begins in January and ends in December) is used by the majority of businesses to generate financial reports. Other corporations, on the other hand, end their fiscal year in June or September. Because it is required by their organization or local government.
The fiscal year of a company is one year, however, it is not required to begin in January. The corporation chose a different starting month for a variety of reasons.
Why Does the Company Use a Different Fiscal Year?
|Group Policy||As for the subsidiaries, the report must be consolidated with the parent company. So the subsidiaries must follow the parent’s fiscal year event it is different from the calendar year.|
|Internal Management||The top management may decide to set a fiscal year other than the calendar year which enables them to review reports on time. They may be busy during the calendar year-end. This practice mostly happens in a small company that is not involved with a complex transactions.|
|Revenue Cycle||The company may set the fiscal year base on the revenue cycle to ensure the accuracy of the income statement. It would be hard to record accrued revenue at the end of the year and the amount is significant. It is popular in the agriculture business.|
|Management Requirement||In some circumstances, management requires a special report for a specific purpose and the period can be different from the calendar year. For example, the company needs to appraise a new project that will cover 18 months period. So they ask for the report over that period.|
|Local regulation||In some countries, the local regulators require the company to prepare a separate report for them. Failing to meet the requirement will result in noncompliance and face subsequent penalties.|
#1. Accounting Periods that are Consistent
It is also possible to have periods that are inconsistent. This predicament usually arises for one of the two reasons listed below.
Start or End of a Partial Period
Because an organization started or stopped activities in the middle of a reporting period, the duration of that period is reduced.
Periods of four weeks
A company’s results may be reported every four weeks, resulting in 13 reporting periods every year. This approach is internally consistent, but the resulting income statements are incongruous when compared to those of an organization that reports using the more standard monthly period.
#2. Durations of Standard Periods
The primary issue with periodicity is whether to generate monthly or quarterly financial statements. Most businesses create monthly statements only to get feedback on operational results on a regular basis. The Securities and Exchange Commission requires publicly traded companies to issue quarterly financial statements, which they may do in addition to monthly statements issued internally. Accounting-wise, producing reports for a large number of reporting periods is more challenging since more accruals are required to allocate business activity across the various periods.
The Importance of Periodicity Assumption
The assumption of periodicity is vital for businesses because it allows them to present their current financial performance to creditors or investors. It ultimately assists businesses in raising fresh investments or loans to suit their financial needs. Investors do not put their money into a company until they conduct a thorough study of its financial performance. Certain restrictive covenants are sometimes linked to a loan. If those terms are not followed, the banks may demand that the loan be repaid immediately. As a result, it is required to provide quarterly financial statements to creditors in order to satisfy them.
Investors are typically interested in a company’s quarterly financial statements in order to forecast the company’s performance for the next quarter. As a result, without a period assumption, it would be impossible to provide such stakeholders with timely financial reporting.
Periodicity Assumption Example
Users of financial statements are interested in an entity’s financial performance. They assess a company’s performance by reading quarterly or interim reports. They can make investment selections after analyzing financial facts. However, because annual financial information is audited, it is preferable. When we compare annual and monthly financial statements, we can see that monthly statements do not provide a complete picture of a corporation as annual financial statements do.
In addition, thorough and detailed notes to the accounts are included in the annual report to help readers better understand the company’s performance and position.
The periodicity assumption is also supported by the matching notion and the revenue recognition principle. Both of these ideas enable organizations to record income and expense transactions for a given time period. Furthermore, financial transactions must be documented in the period of occurrence; even if periods have been arbitrarily determined, the firm must nevertheless adhere to the cut-off idea; otherwise, there may be issues with the reported figures in the business’s financial statement.
Similarly, if a company does not choose a certain accounting period, it may find it difficult to comply with accounting requirements. For example, revenue should be reported when it is earned, according to IFRS.
Assume the company prepares monthly financial reports and earns $500 in revenue in the first month but does not receive payment until the following month. As a result, in such a case, the corporation should include revenue in the current month’s financial statements.
An Example of a Periodicity Assumption in an Income Statement
A good example of a periodicity assumption is the income statement. The data in the income statement is for a certain time period. A business’s year-end income statement reveals the entity’s performance for the entire year. Monthly or quarterly financial statements are issued in addition to annual financial statements. In contrast to the income statement, the balance sheet reflects the financial status on a particular date.
The Benefits of the Periodicity Assumption
The financial statements created on the basis of the periodicity assumption aid in assessing the performance of organizations across certain time periods. This assumption is used to create financial statements on a monthly, quarterly, or annual basis. These periodic financial statements are useful for assessing and analyzing an entity’s position. By reviewing the periodic statements, it is possible to determine which areas of financial statements require attention and what tactics can be effective in achieving higher profit margins (suitable strategies may vary from period to period). Furthermore, fluctuations in sales and other numbers might aid in identifying seasonal variances and planning for shifting customer wants.
Furthermore, certain firms may require management to look around at what’s going on in the company and market. Waiting for the year-end financial accounts will not be a viable alternative in those situations. In this case, a critical examination of monthly or quarterly financial accounts is the best option. That is the fundamental underlying notion driving the application of the periodicity assumption.
To put the periodicity assumptions into practice, the company must first understand and decide which time frame (monthly or quarterly) is best for compiling financial statements. So, after an acceptable time frame has been determined, effective internal controls must be implemented to assure high-quality periodic financial statements.
The company must adhere to the provisions of rules pertaining to accounting, compliance, and taxation. The concept of periodicity is extremely useful in this regard. Banking regulators, for example, required deposit reports, maturity analysis, gap analysis, and maturity analysis on a variety of time scales, including daily, weekly, monthly, quarterly, half-yearly, and yearly. As a result, creating financial statements in different periods aids in the extraction of financial information and compliance with legal requirements.
The periodicity assumption allows for the comparison of financial information from one period to the next.
Using the periodicity assumption, the company can use consistent and uniform accounting treatment to evaluate business profitability and asset valuation.
The systematic display of financial statements aids in the tracking and management of the business’s financial and operational performance. Furthermore, regular comparisons with other organizations aid in a better understanding of business success.
It aids in the timely implementation of relevant measures. This assists in taking relevant steps in a timely manner.
The Periodicity Assumption’s Drawbacks
Some of the drawbacks of the periodicity assumption are as follows.
- A single company transaction may be recorded in more than one accounting period. As a result, it might be difficult to keep track of complex accounting transactions.
- It is frequently difficult to handle and track individual accounting transactions that span multiple accounting periods.
- Due to the use of the periodicity assumption, the company must examine several accounting concepts such as accrual, matching, and cut-off.
What role do periodicity assumptions play in business?
The assumption of periodicity assists the firm in preparing financial statements at regular intervals and identifying any periodic inadequacies in the set of financial information. In addition, the calculation and filing of taxes, budgetary controls, and the application of internal controls provide us with an additional benefit of the periodicity assumption.
The assumption of periodicity implies that a company discloses its financial performance at regular intervals, it assists decision-makers and readers of financial statements in understanding and comparing the company’s performance throughout multiple accounting periods.
The company may report financial data for several time periods, such as weekly, monthly, and yearly. However, after a company has determined its reporting period, it should continue to disclose financial results at the same intervals; this allows financial statement users to track and compare the company’s financial performance.
Furthermore, when the periodicity assumption is used, it becomes easier for the business to implement accounting rules on a regular and uniform basis. Furthermore, periodic data from financial statements can be employed in the tax and other regulatory filing processes.
Periodicity Assumption FAQs
Which accounting principle relates to the periodicity assumption?
The periodicity assumption is also influenced by the matching idea and the revenue recognition accounting principle. Both of these accounting rules enable companies to allocate expenses and report revenues for specific time periods.
How does the periodicity assumption affect an accountant's analysis of accounting transactions?
The periodicity assumption separates time into distinct, consecutive periods. Transactions that occur within each of these time periods can be grouped together with others of a similar origin or source and then collated to create meaningful information about one aspect of the business’s performance over time.
What is the purpose of examining and analyzing trends in a company's financial ratios and other data?
The primary goal of analyzing trends in a company’s financial ratios and other data is to identify anomalies and forecast the future.