What is Periodicity Assumption?
Companies use various accounting principles when preparing their financial statements. These principles include rules and guidelines they must follow when reporting financial data. Usually, accounting principles come from an accounting body that dictates the accounting standards. For example, the Financial Accounting Standards Board (FASB) issues the Generally Accepted Accounting Principles (GAAP).
Most companies follow various accounting principles when preparing their financial statements. These principles may vary based on the standard framework a company uses. Nonetheless, they remain the same for most companies. Accounting principles also form a basis that companies use to apply various accounting standards. On top of that, these principles also allow for a standardized accounting principle to exist throughout the world.
Accounting principles play a crucial role in the financial reporting process. All companies must follow some specific principles when reporting their operations. In some cases, the jurisdiction in which a company operates dictates which of those principles will apply. Nonetheless, those principles do not differ significantly from ones commonly used worldwide. One of these principles includes the periodicity assumption.
What is the Periodicity Assumption?
The periodicity assumption allows companies to divide their activities into an artificial period. In most cases, companies prepare financial statements based on fiscal years. Sometimes, they may also use tax years for that preparation. However, the periodicity assumption requires companies to report results based on the period required. This period may differ from the fiscal or tax year used for other purposes.
Another name used for the periodicity assumption is the period principle. It states that a company must report its operations over a standard period. Through this requirement, it creates a standard for comparable periods. In that context, it also relates to the consistency principle. This principle states that companies must use the same principles or methods unless a better option is available.
The periodicity assumption plays a crucial role in enhancing the comparability of financial statements. In the absence of this principle, companies may report their results for irregular periods. Therefore, it may not suit stakeholders to use those statements to compare the information. Companies must also state the period used in the headings in each financial statement. This requirement also comes from the formats laid by the accounting standards.
Overall, the periodicity assumption is one of the crucial accounting principles. It applies to the balance sheet, income statement, cash flow statement, and statement of changes in equity. The periodicity assumption states that companies must report those statements to a specific period. As mentioned, it may involve preparing them annually, quarterly, or monthly. These periods are called accounting years or accounting periods.
How does the Periodicity Assumption work?
The periodicity assumption allows companies to measure their performance. Usually, companies operate a continuous accounting cycle. With this cycle, they record transactions as they occur. If companies do not separate these records into different periods, it is challenging to measure that performance. The periodicity assumption works on that base. It requires companies to record transactions based on a separate period.
Based on transactions recorded in separate periods, companies can prepare financial statements. As mentioned, each of these statements covers that specific period. In the absence of the period assumption, companies cannot compile and compare transactions. On top of that, stakeholders cannot measure a company’s performance for the period. Therefore, the periodicity assumption is also crucial in that regard.
The periodicity assumption works on the criteria for companies to have consistent periods for accounting. These periods help prepare comparable financial statements. As mentioned, companies can choose the duration which those statements cover. Usually, companies report their financial performance for a year or quarter. These periods are prevalent among various companies worldwide.
In some cases, companies may also report their finances for irregular accounting periods. Companies may come across the need to do so for various reasons. For example, they may have a partial start or end to the accounting period. On top of that, some companies may report their finances for four-week periods instead of monthly. It creates 13 reporting periods instead of the more standard 12.
For most companies, the periodicity assumption is crucial to choosing reporting periods. Some companies may find it challenging to choose between monthly or quarterly financial statements. Most companies produce monthly financial statements. However, it may create challenges with the increased workload for most companies. Furthermore, the jurisdiction or market in which a company operates also dictates the frequency of those reports.
Why is the Periodicity Assumption important?
The periodicity assumption plays a crucial role in the accounting process of many companies. It allows companies to report their financial performance to stakeholders for a specific period. Therefore, it separates their activities into various comparable portions. The periodicity assumption is also important for stakeholders, specifically investors. In the absence of this accounting principle, reporting financial performance becomes complicated.
Through the periodicity assumption, investors can analyze a company’s performance during a period. With this assumption, companies prepare monthly, quarterly, or annual financial statements. These statements enable investors to assess and analyze a company’s financial position. Furthermore, it can also help companies internally in identifying areas for improvement. Similarly, this assumption enables separating seasonal variations.
The periodicity assumption also allows companies to respond to their environments much better. Usually, when companies prepare financial statements, they can assess their performance for that period. The later this process occurs, the more variances will exist between those performances. With the periodicity assumption, however, the preparation of financial statements occurs consistently. Therefore, it allows for better reactions to adverse changes.
The periodicity assumption plays a significant role in informing users about the period of financial performance. As stated above, companies must mention the period for each financial statement in the heading. Therefore, it allows stakeholders to understand the period for which companies prepare those statements. By doing so, it makes the comparison between various periods more straightforward.
The periodicity assumption follows the principle that companies can divide their financial activities. This division occurs on an artificial period basis. Therefore, it assumes companies can separate their revenues and expenses into distinct and consecutive accounting periods. In some cases, that may not be possible. However, that does not limit the importance of the periodicity assumption.
Instead, it requires companies to estimate the transactions to a specific period. For example, companies can use depreciation to spread an asset’s cost over its useful life. On top of that, the period assumption also dictates how companies use other accounting principles. For example, it plays a crucial role in separating accrued and prepaid expenses.
Companies must adhere to various accounting principles, including the periodicity assumption. This principle requires companies to prepare financial statements for separate periods. Usually, it assumes that the separation of activities is possible. Even if it is not, it allows companies to estimate their performance for that specific period. The periodicity assumption forms the basis for periodic financial statement reporting.