Interim reporting refers to a requirement by the securities regulator for most publicly held companies to file quarterly or semiannual information. The intent of this requirement is to provide users of the financial statements with more current information, which often is somewhat abbreviated compared to full annual financial reporting.
This post explains “Interim Financial Statement Reporting” Standard based on IAS 34. Please note: This post isn’t intended to replace the original standard (the IAS-34,) neither is purposed as a supplement of the standard. It aims to provide explanation with “easier-to-understand” language (less technical) so that more people (at least reader of this site) get better understanding about the standard.
Views (Methodology) Used In Preparing Interim Financial Statement
There are two views of how interim financial statements should be prepared:
1. Integral view – Under this methodology, interim period is considered to be an integral part of the annual accounting period. As such, annual expenses that may not arise specifically during an interim period nonetheless are accrued within all interim periods, based on management’s best estimates. This heightened level of accrual usage likely will result in numerous accrual adjustments in subsequent periods to deal with any earlier estimation errors. It also calls for the use of the estimated annual tax rate for all interim periods, since the annual tax rate may vary considerably from the rate in effect during the interim period if the company is subject to graduated tax rates.
2. Discrete view – Under this methodology, each interim period is considered to be a discrete reporting period and as such is not associated with expenses that may arise during other interim periods of the reporting year. A result of this thinking is that an expense benefiting more than one interim period will be fully recognized in the period incurred rather than being recognized over multiple periods.
Although IAS 34, Interim Financial Reporting, generally favors a discrete view (no 2 above), exemplify an approach that is a combination of the discrete and the integral views.
IAS 34 sets forth these three important aspects of interim financial reporting:
- Permitting presentation of condensed financial information by the standard is not intended to either prohibit or discourage the reporting entity from presenting a complete set of interim financial statements, as defined by IAS 1.
- Even when the choice is made to present condensed interim financial statements, if an entity chooses to add line items or additional explanatory notes to the condensed financial statements, over and above the minimum prescribed by this Standard, the Standard does not, in any way, prohibit or discourage the addition of such extra information.
- The recognition and measurement guidance in IAS 34 applies equally to a complete set of interim financial statements as to condensed interim financial statements. Thus, a complete set of interim financial statements would include not only the disclosures specifically prescribed by this Standard but also disclosures required by other IFRS. For example, disclosures required by IAS 32, such as those pertaining to interest rate risk or credit risk, would need to be incorporated in a complete set of interim financial statements, in addition to the selected footnote disclosures prescribed by IAS 34.
Complete Set of Financial Statement (IAS 1 – 2007 Revision)
IAS 1 (as revised in 2007) defines a complete set of financial statements to be comprised of the following:
- A statement of financial position as at the end of the period;
- A statement of comprehensive income for the period;
- A statement of changes in equity for the period;
- A statement of cash flows for the period;
- Notes, comprising a summary of significant accounting policies and other explanatory information; and
- A statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements.
Minimum Requirements for Condensed Format
IAS 34 provides minimum requirements in relation to condensed interim financial reports. The Standard mandates that these financial statements components be presented when an entity opts for the condensed format:
- A condensed statement of financial position
- A condensed statement of comprehensive income, presented as either (1) A condensed single statement, or (2) A condensed separate income statement and a condensed statement of comprehensive income
- A condensed statement of changes in equity
- A condensed statement of cash flows
- A set of selected footnote disclosures
Form and Content Requirements For Interim Financial Statement
IAS 34 sets forth five requirements in relation to form and content of interim financial statements:
- IAS 34 mandates that if an entity chooses to present the “complete set of (interim) financial statements” instead of opting for the allowed method of presenting only “condensed” interim financial statements, then the form and content of those statements should conform to the requirements set by IAS 1 for a complete set of financial statements.
- However, if an entity opts for the condensed format approach to interim financial reporting, IAS 34 requires that, at a minimum, those condensed financial statements include each of the headings and the subtotals that were included in the entity’s most recent annual financial statements, along with selected explanatory notes, as prescribed by the Standard.
- IAS 34 requires disclosure of earnings per share (both basic EPS and diluted EPS) on the face of the interim income statement. This disclosure is mandatory whether condensed or complete interim financial statements are presented.
- IAS 34 mandates that an entity should follow the same format in its interim statement showing changes in equity as it did in its most recent annual financial statements.
- IAS 34 requires that an interim financial report be prepared on a consolidated basis if the entity’s most recent annual financial statements were consolidated statements. Regarding presentation of separate interim financial statements of the parent company in addition to consolidated interim financial statements, if they were included in the most recent annual financial statements, this Standard neither requires nor prohibits such inclusion in the interim financial report of the entity.
IAS 34 includes a list of 10 minimum disclosures required to accompany the condensed interim financial statements, which are outlined next:
- A statement that the same accounting policies and methods of computation are applied in the interim financial statements compared with the most recent annual financial statements, or if those policies or methods have changed, a description of the nature and effect of the change
- Explanatory comments about seasonality or cyclicality of interim operations
- The nature and magnitude of significant items affecting interim results that are unusual because of nature, size, or incidence.
- Dividends paid, either in the aggregate or on a per-share basis, presented separately for ordinary (common) shares and other classes of shares
- Revenue and operating result for business segments or geographical segments, whichever has been the entity’s primary mode of segment reporting
- Any significant events occurring subsequent to the end of the interim period
- Issuances, repurchases, and repayments of debt and equity securities
- The nature and quantum of changes in estimates of amounts reported in prior interim periods of the current financial year, or changes in estimates of amounts reported in prior financial years, if those changes have a material effect in the current interim period
- The effect of changes in the composition of the entity during the interim period, such as business combinations, acquisitions, or disposal of subsidiaries, and long-term investments, restructuring, and discontinuing operations
- The changes in contingent liabilities or contingent assets since the most recent annual financial statements IAS 34 provides examples of the disclosures that are required. For instance, an example of an unusual item is “the write-down of inventories to net realizable value and the reversal of such a write-down.”
Finally, in the case of a complete set of interim financial statements, the Standard allows additional disclosures mandated by other IFRS. However, if the condensed format is used, then additional disclosures required by other IFRS are not required.
Year-To-Date (YTD) Requirements
IAS 34 furthermore mandates not only comparative (condensed or complete) interim income statements (e.g., the second quarter of 2005 presented together with the second quarter of 2004) but the inclusion of year-to-date information as well (e.g., the first half of 2005 and also the first half of 2004).
Thus, an interim income statement would ideally be comprised of four columns of data. In the case of the remaining components of interim financial statements (i.e., balance sheet, statement of cash flows, and statement of changes in equity), however, the presentation of two columns of data would meet the requirements of IAS 34.
- The ABC Company presents quarterly interim financial statements and its financial year ends on December 31 each year. For the second quarter of 2007, ABC Company should present these financial statements (condensed or complete) as of June 30, 2007:
- A statement of comprehensive income with four columns, presenting information for the three-month periods ended June 30, 2007, and June 30, 2006; and for the six month periods ended June 30, 2007, and June 30, 2006.
- A statement of financial position with two columns, presenting information as of June 30, 2007, and as of December 31, 2006.
- A statement of cash flows with two columns presenting information for the six-month periods ended June 30, 2007, and June 30, 2006.
- A statement of changes in equity with two columns presenting information for the six-month periods ended June 30, 2007, and June 30, 2006.
“Rolling 12-Month Statement” Suggestion
IAS 34 recommends that, for highly seasonal businesses, the inclusion of additional income statement columns for the 12 months ending on the date of the most recent interim report (also referred to as “rolling 12-month statements”) would be deemed very useful.
Rolling 12-month statements are recommended because seasonality concerns would be thereby eliminated, since by definition each rolling period contains all the seasons of the year. (Rolling statements, however, cannot correct cyclicality that encompasses more than one year, such as that of secular business expansions and recessions.)
Accordingly, IAS 34 encourages companies affected by seasonality to consider including these additional statements, which could result in an interim income statement comprising six or more columns of data.
Inventory Costing Principle For Interim Financial Reporting
In general, the same inventory costing principles should be utilized for interim reporting as for annual reporting.
However, the use of estimates in determining quantities, costs, and net realizable values at interim dates will be more pervasive. For example, normal year-end closing would require the use of a physical inventory count or perpetual recordkeeping system to ensure that the correct cost of goods sold is recorded.
However, it is acceptable instead to use the gross profit method for an interim period. Under the gross profit method, one can estimate the cost of goods sold based on the expected gross profit percentage.
Two particular difficulties regarding inventory costing principles are addressed in IAS 34, these are, Determining net realizable values (NRV) at interim dates and the allocation of manufacturing variances. Regarding net realizable value determination, the Standard requires that the determination of NRV at interim dates should be based on selling prices and costs to complete at those dates. Projections should therefore not be made regarding conditions that possibly might exist at the time of the fiscal year-end.
Furthermore, write-downs to NRV taken at interim reporting dates should be reversed in a subsequent interim reporting period only if it would be appropriate to do so at the end of the financial year.
IAS 34 requires that the price, efficiency, spending, and volume variances of a manufacturing entity are recognized in income at interim reporting dates to the extent those variances would be recognized at the end of the financial year.
A number of expenses can be assigned to multiple interim reporting periods, even if they are incurred in only one interim period. The key justification is that the costs must clearly benefit all periods in which the expense is recorded. Examples of such expenses are:
- Advertising expense
- Bonuses (if they can be reasonably estimated)
- Contingencies (that are probable and subject to reasonable estimation)
- Contingent rental expense (if the contingent expense appears probable)
- Income taxes (based on the estimated annual effective tax rate)
- Profit sharing (if they can be reasonably estimated)
- Property taxes
Income Tax Assessment
The fact that income taxes are assessed annually by the taxing authorities is the primary reason for the requirement that taxes are to be accrued based on the estimated average annual effective tax rate for the full fiscal year.
Further, if rate changes have been enacted to take effect later in the fiscal year (while some rate changes take effect in midyear, more likely this would be an issue if the entity reports on a fiscal year and the new tax rates become effective at the start of a calendar year), the expected effective rate should take into account the rate changes as well as the anticipated pattern of earnings to be experienced over the course of the year.
Thus, the rate to be applied to interim period earnings (or losses) will take into account the expected level of earnings for the entire forthcoming year as well as the effect of enacted (or substantially enacted) changes in the tax rates to become operative later in the fiscal year. When an interim period loss gives rise to a tax loss carryback, it should be fully reflected in that interim period. Similarly, if a loss in an interim period produces a tax loss carryforward, it should be recognized immediately, but only if the criteria set forth in IAS 12 are met. Specifically, it must be deemed probable that the benefits will be realizable before the loss benefits can be given formal recognition in the financial statements.
Anticipating Volume Rebates or Other Contractual Changes In Pricing
IAS 34 prescribes that where volume rebates or other contractual changes in the prices of goods and services are anticipated to occur over the annual reporting period, these should be anticipated in the interim financial statements for periods within that year.
The rule regarding depreciation and amortization in interim periods is more consistent with the discrete view of interim reporting. Charges to be recognized in the interim periods are to be related to only those assets actually employed during the period; planned acquisitions for later periods of the fiscal year are not to be taken into account.
Impairment Testing At Interim Period
IAS 34 stipulates that an entity should apply the same impairment testing, recognition, and reversal criteria at an interim period as it would at the end of its financial year.
However, this does not mean that a detailed impairment calculation as prescribed by IAS 36 would automatically need to be used at interim periods; instead, an entity would need to review for indications of significant impairments since the date of the most recent financial year to determine whether such a calculation is required.
Where IAS 21 provides for translation adjustments to be recognized in the income statement in the period in which they arise, IAS 34 stipulates that the same approach be applied during each interim period. If the adjustments are expected to reverse before the end of the financial year, IAS 34 requires that entities not defer some foreign currency translation adjustments at an interim date.
Change in Accounting Policy and Estimate
A change in accounting policy other than one for which the transition is specified by a new standard should be reflected by restating the financial statements of prior interim periods of the current year and the comparable interim periods of the prior financial year. However, a change in accounting estimate is to be accounted for only on a go-forward basis, so no retrospective application is allowed.
While year-to-date financial reporting is not required, although the Standard does recommend it in addition to normal interim period reporting, in general, adjustments should not be made to results of earlier interim periods.
By measuring income and expense on a year-to-date basis and then effectively backing into the most recent interim period’s presentation by deducting that which was reported in earlier interim periods, the need for retrospective adjustment of information that was reported earlier is obviated. However, there may be the need for disclosure of the effects of such measurement strategies when this results effectively in including adjustments in the most current interim period’s reported results.