The periodicity assumption or time period assumption states that businesses can divide up their activities into artificial time periods. Since outside financial statement users want timely financial information, the time period assumption allows us to prepare financial statements on a monthly, quarterly, and annually basis.
Even though the going concern assumption dictates that businesses should be treated as if they will continue indefinitely, it is helpful to view business performance in shorter time frames. The periodicity assumption is important to financial accounting because it allows businesses to show current performance to investors and creditors for shorter periods of time.
Investors and creditors want the most current information possible to base their financial decisions on. For instance, investors often look at quarterly financial statements in order to predict what the business performance might be in the next quarter. Without the time period assumption, businesses wouldn’t be able to issue these timely reports.
Examples
– The periodicity assumption is an interesting compromise between accounting relevance and reliability. Outside users of financial statements want financial information as soon as possible in order for it to be relevant in their decision-making. Unfortunately, the more frequent the information is issued, the less reliable it is. For instance, monthly financial statements give investors great performance information in a timely manner. Although, a single month financial statement shows a far less accurate picture of the business compared to an annual financial statement. Investors either have to wait for reliability or compromise with relevance.
– The matching concept and revenue recognition principle also contribute to the periodicity assumption. Both of these accounting principles allow businesses to allocated expenses and record revenues for specific periods of time. For instance, the revenue recognition principle requires that revenue be recorded when earned. If a company issues monthly financial statements and earns $1,000 of revenue on the 31st of the month but doesn’t get paid until the first of the following month, the company must include that revenue in its current month financial statements.
– The income statement is the financial statement that best shows the periodicity assumption. The income statement presents the business performance for a given time period. A year-end income statement shows the income and expense performance for the company for the entire year. Monthly and quarterly income statements are often issued as well. The balance sheet, on the other hand, only shows a picture of the company on a single date in time. The balance sheet does not reflect a period of time but rather a moment in time.
