Periodicity assumption states that a business can report its financial information in any designated period of time. It means that they can divide the activities of a business into an artificial period. That’s the reason why the periodicity assumption is preferred while presenting financial information. This assumption allows the companies to prepare their financial statements monthly, quarterly, semi-annually, or annually.
However, for the sake of comparability, the period once chosen must be followed. Otherwise, it will be difficult to measure the performance of an entity based on a comparison with prior years or periods. If calendar months are chosen this year for the presentation of financial performance, then the use of the same periods for the upcoming year will be better.
Although, companies can change their reporting periods to enhance the use of the financial statement. However, it will lead to changes in the deadline for filing accounts and tax returns.
Importance of Periodicity Assumption
Periodicity assumption is important for businesses as it allows the organizations to present their current financial performance to creditors or investors. It ultimately helps the companies to raise new investments or loans to meet the financial requirements of a business. Investors don’t invest their money without proper investigation of the financial performance of an entity. Sometimes, there are certain restrictive covenants attached to a loan. If those conditions are not met, then the banks may demand immediate repayment of the loan. Therefore, it is necessary to show the creditors the periodic financial statements to satisfy them.
Investors are usually interested in quarterly financial statements of a business to figure out the performance of a business in the next quarter. So, without a period assumption, it would not be possible to issue timely financial reports for such stakeholders.
The users of financial statements are interested in the financial performance of an entity. They analyze the performance of a business by interpreting quarterly or interim reports. The analysis of financial data enables them to make investment decisions. However, it is better to use annual financial information as it is audited. If we evaluate annual and monthly financial statements, we can deduce that monthly statements don’t give a perfect picture of a business compared to annual financial statements.
Further, comprehensive and detailed notes to the accounts are reported in the annual report to better understand the business performance and position.
The matching concept and revenue recognition principle also support the periodicity assumption. Both of these concepts allow businesses to record revenue and expenses transactions for a specific period. Further, financial transactions must be recorded in the period of occurrence; although periods have been artificially set, the business still needs to take care of the cut-off concept; otherwise, there may be problems with the reported figures in the business’s financial statement.
Likewise, if the business does not select a specific accounting period, it can be difficult to comply with the accounting standards. For instance, according to IFRS, revenue should be recorded when earned.
Suppose the company prepares monthly financial reports and earns $500 revenue in the 1st month, but they receive payment in the following month. So, in such a situation, the company should record revenue in the current month’s financial statements.
Income statement – An example of periodicity assumption
The income statement itself is a good example of a periodicity assumption. The information presented in the income statement is for a specific period. As the year-end income statement of a business shows the entity’s performance for a whole year. In addition to annual financial statements, monthly or quarterly financial statements are also issued. However, contrary to the income statement, the balance shows the financial position on a specific single date.
Advantages of the periodicity assumption
The financial statements prepared based on periodicity assumption help assess the performance of companies in specific periods. This assumption is used to prepare monthly, quarterly, or annual financial statements. These periodic financial statements are useful to assess and analyze the position of an entity. By analyzing the periodic statements, it can be suggested which area of financial statements needs proper consideration and what strategies might be useful to attain better profit margins (suitable strategies may vary from period to period). Further, fluctuation in sales and other figures can help identify seasonal variations and plan for the changing demands of the customers.
In addition to this, some businesses may require the management to look around what’s happening in the company and market. So, under those circumstances, it won’t be a feasible option to wait for the year-end financial statements. The critical analysis of monthly or quarterly financial statements will be the right choice in such a situation. That’s the main underlying principle behind the use of periodicity assumption.
To implement the periodicity assumptions practically, the business needs to understand and identify which time frame (i.e., monthly or quarterly) is better for preparing financial statements. So, after selecting an appropriate time frame, effective internal controls must be applied to ensure good quality periodic financial statements.
The business needs to comply with the provisions of regulations related to accounting, compliance, and taxation. The concept of periodicity greatly helps in this regard. For instance, banking regulators required deposit reports, maturity analysis, gap analysis, and maturity analysis on varying periods, including daily, weekly, monthly, quarterly, half-yearly, and yearly. So, preparing the financial statement in different periods helps extract financial information and comply with the provisions of law.
Comparison of the financial information from period to period becomes possible due to the application of the periodicity assumption.
The business can apply consistent and uniform accounting treatment to calculate business profitability and valuation of assets by using periodicity assumption.
Systematic presentation of the financial statement helps track and manage the financial and operational performance of the business. Further, systematic comparisons with different companies help to better understand the business performance.
It helps to take appropriate measures on a timely basis. This helps to take appropriate steps on a timely basis.
Disadvantages of the periodicity assumption
Following are some of the disadvantages of the periodicity assumption.
- A single business transaction may fall in multiple accounting periods. Hence, it can be difficult to track complex accounting transactions.
- It’s often difficult to manage and track specific accounting transactions that fall in more than one accounting period.
- The business needs to consider multiple accounting concepts like accrual, matching, and cut-off due to the usage of the periodicity concept.
The link between regulatory filing and periodicity concept
Periodicity assumption divides reporting of financial information in different months and periods. The regulations require operational and financial reporting at different points that are helped by extracting information from different financial statements.
Periodicity assumption means that a business reports its financial performance after certain intervals; it helps decision-makers and users of the financial statement understand and compare the performance of the business through different accounting periods.
The business may report its financial information for different periods, including weekly, monthly, and yearly. However, once the business has decided its reporting period, it should continue to report the financial performance at the same intervals; it helps financial statement users track and compare the business’s financial performance.
In addition, it becomes easy for the business to apply accounting principles on a consistent and uniform basis when the business applies the periodicity concept. Further, periodic data from financial statements can be used in the process of filing for the tax and other regulatory formalities.
Frequently asked questions
How do periodicity assumptions help the business?
Periodicity assumption helps the business prepare financial statements after the regular interval and identify any periodic shortcomings in the set of financial information. Further, calculation and filing of the tax, budgetary controls, and application of internal controls measure us an additional benefit of periodicity assumption.
What is the time interval concept?
The Interval concept is the second name of the periodicity concept, and it refers to the presentation of financial information after regular time intervals.
What are the five types of accounting assumptions?
Five types of accounting assumptions include the following.
- Period concept (periodicity concept)
- Going concern concept
- Economic entity concept
- Reliability concept
- Consistency concept
How cut off is linked with the periodicity concept?
Cut-off means the transaction of some specific period should be posted in the same accounting period, and it’s based on the posting date. Hence, the cut-off is closely related to the periodicity concept.
Cut off is when accounting period changes and subsequent transactions need to be posted in the following accounting periods.
Provide an example of the periodicity concept.
Formation and presentation of the quarterly financial statement is an example of the periodicity concept. The transaction for a specific month used in the one quarter cannot be used in the next quarter.
Why is periodicity assumption important in accounting?
The periodicity assumption is important in accounting because it helps to divide reporting information into different periods, which helps track and manage business performance. Mostly, companies adopt reporting periods in line with the market as it helps them in comparing their performance with the market.