Interim financial reporting has become an important topic in accounting. There h
ID: 2498213 • Letter: I
Question
Interim financial reporting has become an important topic in accounting. There has been considerable discussion as to the proper method of reflecting results of operations at interim dates. Accordingly. The Accounting Principles Board issued an opinion clarifying some aspects of interim reporting. Discuss generally how revenue should be recognized at interim dates and specifically ho revenue should be recognized for industries subject to large seasonal fluctuations in revenue and for a longterm contracts using the percentage of completion method at annual reporting dates. Discuss generally how product and period costs should be recognized at interim dates. Also discuss how inventory and cost of goods sol may be afforded special accounting treatment at interim dates. Discuss how the provision for income taxes is computed and reflected in interim financial statements.Explanation / Answer
Answer:(a) Sales and other revenues should be recognized for interim financial statement purposes in the same manner as revenues are recognized for annual reporting purposes. This means normally at the point of sale or, in the case of services, at completion of the earnings process.
In the case of industries whose sales vary greatly due to the seasonal nature of business, revenues should still be recognized as earned, but a disclosure should be made of the seasonal nature of the business in the notes.
In the case of long-term contracts recognizing earnings on the percentage-of-completion basis, the current state of completion of the contract should be estimated and revenue recognized at interim dates in the same manner as at the normal year end.
Answer:(b) For interim reporting purposes, product costs (costs directly attributable to the production of goods or services) should be matched with the product and associated revenues in the same manner as for annual reporting purposes.
Period costs (costs not directly associated with the production of a particular good or service) should be charged to earnings as incurred or allocated among interim periods based on an estimate of time expired, benefit received, or other activity associated with the particular interim period(s). Also, if a gain or loss occurs during an interim period and is a type that would not be deferred at year end, the gain or loss should be recognized in full in the interim period in which it occurs. Finally, in allocating period costs among interim periods, the basis for allocation must be supportable and may not be based on merely an arbitrary assignment of costs between interim periods. The profession allowed for some variances from the normal method of determining cost of goods sold and valuation of inventories at interim dates in APB Opinion No. 28, but these methods are allowable only at interim dates and must be fully disclosed in a note to the financial statements. Some companies use the gross profit method of estimating cost of goods sold and ending inventory at interim dates instead of taking a complete physical inventory. This is an allowable procedure at interim dates, but the company must disclose the method used and any significant variances that subsequently result from reconciliation of the results obtained using the gross profit method and the results obtained after taking the annual physical inventory.
At interim dates, companies using the LIFO cost-flow assumption may temporarily have a reduction in inventory level that results in a liquidation of base period layers of inventory. If this liquidation is considered temporary and is expected to be replaced prior to year end, the company should charge cost of goods sold at current prices. The difference between the carrying value of the inventory and the current replacement cost of the inventory is a current liability for replacement of LIFO base inventory temporarily depleted. When the temporary liquidation is replaced, inventory is debited for the original LIFO value and the liability is removed.
Inventory losses from a decline in market value at interim dates should not be deferred but should be recognized in the period in which they occur. However, if in a subsequent interim period the market price of the written-down inventory increases, a gain should be recognized for the recovery up to the amount of the loss previously recognized. If a temporary decline in market value below cost can reasonably be expected to be recovered prior to year end, no loss should be recognized.
Finally, if a company uses a standard cost system to compute cost of goods sold and to value inventories, variances from the standard should be deferred instead of being immediately recognized.
Answer:(c) The Board states that the provision for income taxes shown in interim financial statements must be based upon the effective tax rate expected for the entire annual period for ordinary earnings. The effective tax rate is, in accordance with previous APB opinions, based on earnings for financial statement purposes as opposed to taxable income which may consider temporary differences. This effective tax rate is the combined federal and state(s) income tax rate applied to expected annual earnings, taking into consideration all anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains rates, and other available tax planning alternatives. Ordinary earnings do not include unusual or extraordinary items, discontinued operations, or cumulative effects of changes in accounting principles, all of which will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year. The amount shown as the provision for income taxes at interim dates should be computed on a year-to-date basis. For example, the provision for income taxes for the second quarter of a company's fiscal year is the result of applying the expected rate to year-to-date earnings and subtracting the provision recorded for the first quarter. There are several variables in this computation (expected earnings may change; tax rates may change), and the year-to-date method of computation provides the only continuous method of approximating the provision for income taxes at interim dates. However, if the effective rate or expected annual earnings change between interim periods, the change is not reflected retroactively but the effect of the change is absorbed in the current interim period.
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