The periodicity assumption states that a company can report its financial information within certain designated or artificial periods of time. This usually means that a company consistently reports its financial information on monthly, quarterly, or annual periods.
To enable comparability and consistency, these time periods are kept the same. So, if the reporting period for the current year is quarterly, then the reporting period to be used next year should also be quarterly.
This is done so that the results of multiple years can be compared every quarter. The period for which a financial statement is prepared appears in its heading.
Inconsistent Periods
A company can have inconsistent periods. This situation normally arises for two reasons:
- Partial period start or end – A company has started or ended its operations part way through a financial period so that one period has a shortened duration.
- Four-week periods – A company may report its results every four weeks, which equals 13 reporting periods every year. This methodology is internally consistent and reliable but can be inconsistent when it comes to comparing income statement results to those of a company that reports using the more traditional monthly period.
The main periodicity issue is whether a company should create monthly or quarterly financial statements. Most companies opt for monthly statements, usually to evaluate their operational results consistently. The Securities and Exchange Commission requires publicly-held businesses to issue financial statements quarterly, which could be issued alongside monthly statements that are conducted for internal use.
From an accounting perspective, producing reports for several reporting periods is very difficult, because business activities need more accruals to be apportioned among the various periods.
Once the standard periods have been decided upon for reporting financial statements, accounting procedures are created to support the ongoing reporting of financial statements for the designated periods. This means that a series of activities will decide when accruals are to be posted, as well as the standard structure of the resulting journal entries.
Advantage of Periodicity Assumption
Utilizing financial reports that are readied based on the going concern idea is very hard for the executives to control and evaluate the presentation of the organizations.
However, by utilizing the financial statements that get prepared according to the periodicity assumption, the analysts have week-by-week, month-to-month, or quarter-to-quarter information to evaluate and assess the company's performance, including its financial position.
The analysts of financial reports need reliable and accurate information to assess the financial position of the companies for making key decisions and taking appropriate measures. The periodic assumption gives companies the ability to divide their financial and economic activities into brief periods. For each period, companies plan and distribute a series of financial statements to address the needs of their users.
The income statement allows interested individuals to see how effectively and profitably a company has conducted its activities during a particular period. The balance sheet, on the other hand, shows investors the financial position of the business towards the end of the period. Statement of cash flows shows the inflows and outflows of cash and cash equivalents during the period and why these occurred. The statement of retained earnings shows the portion of the company’s profit that was kept in the business for future expansion and what portion of the profit was distributed among the shareholders in the form of dividends.
This financial information is significant for the management, board of directors, investors, banks, government, rating agencies, and other users of the financial statements, as it helps them make decisions on what to do and what to avoid doing in the future. The time period assumption encourages the use of the most recent and reliable information by those preparing the statements so that timely decisions can be made for the benefit of the company.
Operating the business occasionally requires the executives to recognize what precisely occurs in the company as well as outside of it, which includes the general market. Sitting tight for yearly financial statements is not the correct decision.
In this manner, the reason for planning financial statements according to the periodicity assumption is that the financial statements could be prepared and presented in artificial periods of time. That plan is based on the periodicity assumption which permits them to see the budgetary presentation all the more precisely as deliberately significant.
It also enables a company to stop and measure how successful it has been in achieving its objectives during a particular time period and see where improvements can be made.
Implementation
For the effective implementation of the periodicity assumption, a company needs to figure out the time frame that financial statements are required to get ready. When the time frame is identified, internal controls on financial reporting can then be put into place to ensure its proper implementation. There also needs to be continuous assessments and improvements to be effective over the long term.
Examples
- XYZ Limited provides services worth $10,000 to ABC Limited during the first quarter of the year. ABC Limited will make payment for these services in cash next quarter. According to the time period assumption, if XYZ Limited prepares its financial reports at the end of the first quarter of the year, it will have to record this revenue of $10,000 in its income statement for the first quarter.
- The XYZ Limited incurs expenses of $2,000 during the first quarter of the year. These expenses will be paid for in cash in the following quarter. The time period assumption requires XYZ Limited to disclose these expenses on the income statement for the first quarter of the year.
Conclusion
Periodicity assumption brings with it several advantages and is integral when preparing financial statements. It helps when executives of a company want to compare its performance period-wise, giving them the information to make timely decisions for the betterment of the company. Both internal and external shareholders can utilize financial statements effectively and meet their objectives.
FAQs
1. What is a periodicity assumption?
Periodicity assumption is the belief that a company's financial statements should be prepared and presented in artificial periods of time. This allows for a more precise view of the company's financial position and performance.
2. Why is the periodicity assumption important?
The periodicity assumption is important because it enables a company to stop and measure how successful it has been in achieving its objectives during a particular time period. This information can be used to make timely decisions for the benefit of the company.
It also allows for a more accurate comparison of a company's performance over different periods of time. This is beneficial for both internal and external shareholders.
3. How does the periodicity assumption work?
The periodicity assumption requires a company to disclose its financial information, in the same way, each time it reports its financials. This usually means disclosing revenue and expenses on an income statement for monthly, quarterly, or annual periods.
4. Is an income statement an example of a periodicity assumption?
An income statement is an example of a financial statement that follows the periodicity assumption. The income statement discloses revenue and expenses for a particular time period, usually monthly, quarterly, or annual.
5. What are the advantages of the periodicity assumption?
The advantages of the periodicity assumption are that it allows for a more precise view of a company's financial position and performance.
Additionally, it allows for a more accurate comparison of a company's performance over different periods of time.
