Interim financial reports are financial statements covering periods of less than a full fiscal year. Most commonly such reports will be for a period of three months (which are referred to as quarterly financial reports) or semiannual financial reporting.
The purpose of an interim financial report is to provide financial statement users with more timely information for making investment and credit decisions, based on the expectation that full-year results will be a reasonable extrapolation from interim performance. Additionally, interim reports can yield significant information concerning trends affecting the business and seasonality effects, both of which could be obscured in annual reports.
The question is: what statement and disclosures should be presented in an interim financial report? Before going to the main topic, here is inherent limitation of interim reporting, coming first.
Limitation of Interim Reporting
The basic objective of interim reporting is to provide frequent and timely assessments of an entity’s performance. However, interim reporting has inherent limitations. As the reporting period is shortened, the effects of errors in estimation and allocation are magnified.
The proper allocation of annual operating expenses to interim periods is also a significant concern. Because the progressive tax rates of most jurisdictions are applied to total annual income and various tax credits may arise, the accurate determination of interim period income tax expense is often difficult. Other annual operating expenses may be concentrated in one interim period, yet benefit the entire year’s operations.
Examples include advertising expenses and major repairs or maintenance of equipment, which may be seasonal in nature. The effects of seasonal fluctuations and temporary market conditions further limit the reliability, comparability, and predictive value of interim reports. Because of this reporting environment, the issue of independent auditor association with interim financial reports remains problematic.
The argument is often made that interim reporting is generically unlike financial reporting covering a full fiscal year. Two distinct views of interim reporting have developed, representing alternative philosophies of financial reporting:
- The First View – The interim period is considered to be an integral part of the annual accounting period. This view directs that annual operating expenses are to be estimated and then allocated to the interim periods based on forecasted annual activity levels, such as expected sales volume. When this approach is employed, the results of subsequent interim periods must be adjusted to reflect prior estimation errors.
- The Second View – Each interim period is considered to be a discrete accounting period, with status equal to a fiscal year. Thus, no estimations or allocations that are different from those used for annual reporting are to be made for interim reporting purposes. The same expense recognition rules should apply as under annual reporting, and no special interim accruals or deferrals are to be permitted. Annual operating expenses are recognized in the interim period in which they are incurred, irrespective of the number of interim periods benefited, unless deferral or accrual would be called for in the annual financial statements.
Proponents of the integral view argue that the unique expense recognition procedures are necessary to avoid creating possibly misleading fluctuations in period-to-period results. Using the integral view results in interim earnings which are hopefully more indicative of annual earnings and, thus, useful for predictive and other decision-making purposes. Proponents of the discrete view, on the other hand, argue that the smoothing of interim results for purposes of forecasting annual earnings has undesirable effects. For example, a turning point in an earnings trend that occurred during the year may be obscured.
Yet others have noted that the distinction between the integral and the discrete approaches is arbitrary and, in fact, rather meaningless. These critics note that interim periods bear the same relationship to full years as fiscal years do to longer intervals in the life cycle of a business, and that all periodic financial reporting necessitates the making of estimates and allocations.
Direct costs and revenues are best accounted for as incurred and earned, respectively, which equates a discrete approach in most instances, while many indirect costs are more likely to require that an allocation process be applied, which is suggestive of an integral approach. In short, a mix of methods will be necessary as dictated by the nature of the cost or revenue item being reported upon, and neither a pure integral nor a pure discrete approach could be utilized in practice.
The IFRS on interim financial reporting, IAS 34, does, in fact, adopt a mix of the discrete and the integral views, as described more fully below.
Content Of An Interim Financial Report
Instead of repeating information previously presented in annual financial statements, interim financial reports should preferably focus on new activities, events, and circumstances that have occurred since the date of publication of the latest complete set of financial statements.
IAS 34 recognizes the need to keep financial statement users informed about the latest financial condition of the reporting entity, and has thus moderated the presentation and disclosure requirements in the case of interim financial reports.
Thus, in the interest of timeliness and with a sensitivity to cost considerations, and also to avoid repetition of information previously (and recently) reported, the standard allows an entity, at its option, to provide information relating to its financial position in a condensed format, in lieu of comprehensive information provided in a complete set of financial statements prepared in accordance with IAS 1.
IAS 34 sets forth the following three important aspects of interim financial reporting:
Aspect-1. That the above concession (i.e., 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.
Aspect-2. That 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.
Aspect-3. That 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 IFRS 7, 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.
So, what are the minimum requirements as to the components of the interim financial statements to be presented (under this option), and what are their content? Read on…
Minimum Components Of An Interim Financial Report
IAS 34 sets forth minimum requirements in relation to condensed interim financial reports. The standard mandates that the following 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
- A condensed statement of cash flows
- A set of selected footnote disclosures
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, then 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.
It is interesting to note that IAS 34 mandates expansiveness in certain cases. The standard notes that extra line items or notes may need to be added to the minimum disclosures prescribed above, if their omission would make the condensed interim financial statements misleading. This concept can be best explained through the following illustration:
At December 2011, an entity’s comparative statement of financial position had trade receivables that were considered doubtful, and hence, were fully reserved as of that date. Thus, on the face of the statement of financial position as of December 31, 2011, the amount disclosed against trade receivables, net of provision, was a zero balance (and the comparative figure disclosed as of December 31, 2010, under the prior year column was a positive amount, since at that earlier point of time, that is, at the end of the previous year, a small portion of the receivable was still considered collectible).
At December 31, 2011, the fact that the receivable (net of the provision) ended up being presented as a zero balance on the face of the statement of financial position was well explained in the notes to the annual financial statements (which clearly showed the provision being deducted from the gross amount of the receivable that caused the resulting figure to be a zero balance that was then carried forward to the statement of financial position).
If at the end of the first quarter of the following year the trade receivables were still doubtful of collection, thereby necessitating creation of a 100% provision against the entire balance of trade receivables as of March 31, 2012, and the entity opted to present a condensed statement of financial position as part of the interim financial report, it would be misleading in this case to disclose the trade receivables as of March 31, 2012, as a zero balance, without adding a note to the condensed statement of financial position explaining this phenomenon.
IAS 34 requires disclosure of earnings per share (both basic EPS and diluted EPS) on the face of the interim statement of comprehensive income. 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.
Selected Explanatory Notes
While a number of notes would potentially be required at an interim date, there could clearly be far less disclosure than is prescribed under other enacted IFRS.
IAS 34 reiterates that it is superfluous to provide the same notes in the interim financial report that appeared in the most recent annual financial statements, since financial statement users have access to those statements in all likelihood. To the contrary, at an interim date it would be meaningful to provide an explanation of events and transactions that are significant to an understanding of the changes in financial position and performance of the entity since the last annual reporting.
In keeping with this line of thinking, it provides a list of minimum disclosures required to accompany the condensed interim financial statements, which are outlined below:
- 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 (profit or loss disclosure only if reviewed by chief operating decision maker);
- 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, like business combinations, acquisitions, or disposal of subsidiaries, and long-term investments, restructuring, and discontinuing operations; and
- 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.
Comparative Interim Financial Statements
IAS 34 endorses the concept of comparative reporting, which is generally acknowledged to be more useful than is the presentation of information about only a single period. This is consistent with the position that has been taken by the accounting profession around the globe for many decades (although comparative reports are not an absolute requirement in some jurisdictions, most notably in the U.S.).
IAS 34 furthermore mandates not only comparative (condensed or complete) interim statements of comprehensive income (e.g., the second quarter of 2012 presented together with the second quarter of 2011), but the inclusion of year-to-date information as well (e.g., the first half of 2012 and also the first half of 2011). Thus, an interim statement of comprehensive income would ideally be comprised of four columns of data.
On the other hand, in the case of the remaining components of interim financial statements (i.e., statement of financial position, statement of cash flows, and statement of changes in stockholders’ equity), the presentation of two columns of data would meet the requirements of IAS 34. Thus, the other components of the interim financial statements should present the following data for the two periods:
- The statement of financial position as of the end of the current interim period and a comparative statement of financial position as of the end of the immediately preceding fiscal year (not as of the comparable year-earlier date);
- The statement of cash flows cumulatively for the current financial year to date, with a comparative statement for the comparable year-to-date period of the immediately preceding financial year; and
- IAS 34 requires that the statement showing changes in equity cumulatively for the current financial year to date be presented, with a comparative statement for the comparable year-to-date period of the immediately preceding financial year.
The following illustration should amply explain the above-noted requirements of IAS 34:
XYZ Limited presents quarterly interim financial statements and its financial year ends on December 31 each year. For the second quarter of 2012, XYZ Limited should present the following financial statements (condensed or complete) as of June 30, 2012:
1. A statement of comprehensive income with four columns, presenting information for the three-month periods ended June 30, 2012, and June 30, 2011; and for the six-month periods ended June 30, 2012, and June 30, 2011
2. A statement of financial position with two columns, presenting information as of June 30, 2012, and as of December 31, 2011
3. A statement cash flows with two columns presenting information for the six-month periods ended June 30, 2012, and June 30, 2011
4. A statement of changes in equity with two columns presenting information for the six-month periods ended June 30, 2012, and June 30, 2011.
IAS 34 recommends that, for highly seasonal businesses, the inclusion of additional statement of comprehensive income columns for the twelve months ending on the date of the most recent interim report (also referred to as rolling twelve-month statements) would be deemed very useful.
The objective of recommending rolling twelve-month statements is that 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 statement of comprehensive income comprising six or more columns of data.