Interim financial reports are financial statements covering periods of less than a full financial year. Most commonly such reports will be for a period of six months (which are referred to as semi-annual financial reports) or three months (which are referred to as quarterly financial reports), depending on relevant jurisdictions. The purpose of interim financial reports 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 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.
Two distinct views of interim reporting have been advocated, particularly by US and UK standard setters, although some believe that this distinction is more apparent than real. The first view holds that the interim period is an integral part of the annual accounting period (the integral view), while the second views the interim period as a unique accounting period of its own (the discrete view). Depending on which view is accepted, expenses would either be recognised as incurred, or would be allocated to the interim periods based on forecasted annual activity levels such as sales volume. The integral approach would require more use of estimation, and forecasts of full-year performance would be necessary antecedents for the preparation of interim reports.
IAS 34, Interim Financial Reporting, does not mandate which entities should be required to publish interim financial reports, how frequently, or how soon after the end of an interim period. Local governments, securities regulators, security exchanges or accounting bodies often govern the application of IAS 34 for entities whose debt or equity securities are publicly traded. IAS 34 applies if an entity elects or is required to apply IAS 34.
An entity's annual financial statements are evaluated independently, from its interim reports, for compliance with IFRS. If an entity's interim report is describe as complying with IFRS, it must comply with all the requirements of IAS 34.
Interim financial report. An interim financial report means a financial report containing either a complete set of financial statements for an interim period (as described in IAS 1), or a set of condensed financial statements (as described in IAS 34) for an interim period.
Interim period. A financial reporting period shorter than a full financial year (e.g., a period of three or six months).
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. Under 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.
Under 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 recognised 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 due 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 to 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 utilised 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.
The purpose of interim financial reporting is to provide information that will be useful in making economic decisions (as, of course, is the purpose of annual financial information). Furthermore, interim financial reporting is expected to provide information specifically about the financial position, performance and change in financial position of an entity. The objective is general enough to embrace the preparation and presentation of either full financial statements or condensed information.
While accounting is often criticised for looking at an entity's performance through the rearview mirror, in fact it is well understood by standard setters that to be useful, such information must provide insights into future performance. As outlined in the objective of the IASB's standard on interim financial reporting, IAS 34, the primary, but not exclusive, purpose of timely interim period reporting is to provide interested parties (e.g., investors and creditors) with an understanding of the entity's earnings-generating capacity and its cash flow-generating capacity, which are clearly future oriented. Furthermore, the interim data is expected to give interested parties insights not only into such matters as seasonal volatility or irregularity, and provide timely notice about changes in patterns or trends, both as to income or cash-generating behaviour, but also into balance sheet-based phenomena such as liquidity.
There is no requirement under IFRS that entities must prepare interim financial statements. Furthermore, even if annual financial statements are prepared in accordance with IFRS, the reporting entity is free to present interim financial statements on bases other than IFRS, as long as they are not misrepresented as being IFRS compliant.
If interim financial statements are IFRS based, IAS 34 states that interim financial data should be prepared in conformity with accounting policies used in the most recent annual financial statements. The only exception noted is when a change in accounting policy has been adopted since the last year-end financial report was issued. The standard also stipulates that the definitions of assets, liabilities, income and expenses for the interim period are to be identical to those applied in annual reporting situations.
While IAS 34, in many instances, is quite forthright about declaring its allegiance to the discrete view of interim financial reporting, it does incorporate a number of important exceptions to the principle.
The standard logically states that interim period financial statements should be prepared using the same accounting principles that had been employed in the most recent annual financial statements. This is consistent with the idea that the latest annual report provides the frame of reference that will be employed by users of the interim information. The fact that interim data is expected to be useful in making projections of the forthcoming full-year's reported results of operations makes consistency of accounting principles between the interim period and prior year important, since the projected results for the current year will undoubtedly be evaluated in the context of year-earlier performance. Unless the accounting principles applied in both periods are consistent, any such comparison is likely to be impeded.
The decision to require consistent application of accounting policies across interim periods and in comparison with the earlier fiscal year is a logical implication of the view of interim reporting as being largely a means of predicting the next fiscal year's results. It is also driven by the conclusion that those interim reporting periods stand alone (rather than being merely an integral portion of the full year). To put it differently, when an interim period is seen as an integral part of the full year, it is easier to rationalise applying different accounting policies to the interim periods, if doing so will more meaningfully present the results of the portion of the full year within the boundaries of the annual reporting period. For example, deferral of certain costs at interim statement of financial position dates, notwithstanding the fact that such costs could not validly be deferred at year-end, might theoretically serve the purpose of providing a more accurate predictor of full-year results.
On the other hand, if each interim period is seen as a discrete unit to be reported upon without having to serve the higher goal of providing an accurate prediction of the full year's expected outcome, then a decision to depart from previously applied accounting principles is less easily justified. Given IAS 34's clear preference for the discrete view of interim financial reporting, its requirement regarding consistency of accounting principles is entirely logical.
The standard also requires that, if the entity's most recent annual financial statements were presented on a consolidated basis, then the interim financial reports in the immediate succeeding year should also be presented similarly. This is entirely in keeping with the notion of consistency of application of accounting policies. The rule does not, however, either preclude or require publishing additional “parent company only” interim reports, even if the most recent annual financial statements did include such additional financial statements.
Materiality is one of the most fundamental concepts underlying financial reporting. At the same time, it has largely been resistant to attempts at precise definition. Some IFRS do require that items be disclosed if material or significant, or if of “such size” as would warrant separate disclosure. Guidelines for performing an arithmetical calculation of a threshold for materiality (in order to measure “such size”) are not prescribed in IAS 1, or for that matter in any other IFRS. Rather, this determination is left to the devices of each individual charged with responsibility for financial reporting.
IAS 34 advanced the notion that materiality for interim reporting purposes may differ from that defined in the context of an annual period. This follows from the decision to endorse the discrete view of interim financial reporting generally. Thus, for example, discontinuing operations would have to be evaluated for disclosure purposes against whatever benchmark, such as gross revenue, is deemed appropriate as that item is being reported in the interim financial statements—not as it was shown in the prior year's financial statements or is projected to be shown in the current full year's results.
The effect of the foregoing would normally be to lower the threshold level for reporting such items. Thus, it is deemed likely that some items separately set forth in the interim financials may not be so presented in the subsequent full year's annual report that includes that same interim period.
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 recognises 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:
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:
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 20XX-1, 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, 20XX-1, the amount disclosed against trade receivables, net of provision, was a zero balance (and the comparative figure disclosed as of December 31, 20XX-2, 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, 20XX-1, 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, 20XX, 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, 20XX, as a zero balance, without adding a note to the condensed statement of financial position explaining this phenomenon.
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 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 are presumed to have access to those statements in all likelihood. To the contrary, the interim financial report provides 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. This information updates the relevant information presented in the most recent annual financial report. In keeping with this line of thinking, the following is a non-exhaustive list of events and transactions that are disclosed, if they are significant:
The additional disclosure below must also be provided in the notes to the interim financial statements on a financial year-to-year basis. These disclosures could also be incorporated by cross-reference from the interim financial statements to some other statement (such as management commentary or risk report) that is available to users of the financial statements on the same terms as the interim financial statements and at the same time. If users of the financial statements do not have access to the information incorporated by cross-reference on the same terms and at the same time, the interim financial report is incomplete.
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.
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. Thus, the other components of the interim financial statements should present the following data for the two periods:
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 20XX, XYZ Limited should present the following financial statements (condensed or complete) as of June 30, 20XX:
IAS 34 recommends that, for highly seasonal businesses, the inclusion of additional financial information for the 12 months ending on the date of the interim report and comparative information for the prior 12-month period (also referred to as rolling 12-month statements) would be deemed very useful. The objective of recommending rolling 12-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.
The definitions of assets, liabilities, income and expense are the same for interim period reporting as for annual reporting. These items are defined in the IASB's Framework. The effect of stipulating that the same definitions apply to interim reporting is to further underscore the concept of interim periods being discrete units of time upon which the statements report. For example, given the definition of assets as resources generating future economic benefits for the entity, expenditures that could not be capitalised at year-end because of a failure to meet this definition could similarly not be deferred at interim dates. Thus, by applying the same definitions at interim dates, IAS 34 has mandated the same recognition rules as are applicable at the end of full annual reporting periods.
However, while the overall implication is that identical recognition and measurement rules are to be applied to interim financial statements, there are a number of exceptions and modifications to the general rule. Some of these are in simple acknowledgement of the limitations of certain measurement techniques, and the recognition that applying those definitions at interim dates might necessitate interpretations different from those useful for annual reporting. In other cases, the standard clearly departs from the discrete view, since such departures are not only wise, but probably fully necessary. These specific recognition and measurement issues are addressed below.
It is frequently observed that certain types of costs are incurred in uneven patterns over the course of a fiscal year, while not being driven strictly by variations in volume of sales activity. For example, major expenditures on advertising may be prepaid at the inception of the campaign; tooling for new product production will obviously be heavily weighted to the preproduction and early production stages. Certain discretionary costs, such as research and development, will not bear any predictable pattern or necessary relationship with other costs or revenues.
If an integral view approach had been designated by IAS 34, there would be potent arguments made in support of the accrual or deferral of certain costs. For instance, if a major expenditure for overhauling equipment is scheduled to occur during the final interim period, logic could well suggest that the expenditure should be anticipated in the earlier interim periods of the year, if those periods were seen as integral parts of the fiscal year. Under the discrete view adopted by the standard, however, such an accrual would be seen as an inappropriate attempt to smooth the operating results over all the interim periods constituting the full fiscal year. Accordingly, such anticipation of future expenses is prohibited, unless the future expenditure gives rise to a true liability in the current period, or meets the test of being a contingency which is probable and the magnitude of which is reasonably estimable.
For example, many business entities grant bonuses to managers only after the annual results are known; even if the relationship between the bonuses and the earnings performance is fairly predictable from past behaviour, these remain discretionary in nature and need not be granted. Such a bonus arrangement would not give rise to a liability during earlier interim periods, inasmuch as the management has yet to declare that there is a commitment that will be honoured. (Compare this with the situation where managers have contracts specifying a bonus plan, which clearly would give rise to a legal liability during the year, albeit one which might involve complicated estimation problems. Also, a bonus could be anticipated for interim reporting purposes if it could be considered a constructive obligation, for example, based upon past practice for which the entity has no realistic alternative, and assuming that a realistic estimate of that obligation can be made.)
Another example involves contingent lease arrangements. Often in operating lease situations the lessee will agree to a certain minimum or base rent, plus an amount that is tied to a variable such as sales revenue. This is typical, for instance, in retail rental contracts, such as for space in shopping malls, since it encourages the landlord to maintain the facilities in an appealing fashion so that tenants will be successful in attracting customers. Only the base amount of the periodic rental is a true liability, unless and until the higher rent becomes payable as defined sales targets are actually achieved. If contingent rents are payable based on a sliding scale (e.g., 1% of sales volume up to €500,000, then 2% of amounts up to €1.5 million, etc.), the projected level of full-year sales should not be used to compute rental accruals in the early periods; rather, only the contingent rents payable on the actual sales levels already achieved should be so recorded.
The foregoing examples were clearly categories of costs that, while often fairly predictable, would not constitute a legal obligation of the reporting entity until the associated conditions were fully met. There are, however, other examples that are more ambiguous. Paid vacation time and holiday leave are often enforceable as legal commitments, and if this is so, provision for these costs should be made in the interim financial statements. In other cases, such as when company policy is that accrued vacation time is lost if not used by the end of a defined reporting year, such costs might not be subject to accrual under the discrete view. The facts of each such situation would have to be carefully analysed to make a proper determination.
IAS 34 is clear in stipulating that revenues such as dividend income and interest earned cannot be anticipated or deferred at interim dates, unless such practice would be acceptable under IFRS at year-end. Thus, interest income is typically accrued, since it is well established that this represents a contractual commitment. Dividend income, on the other hand, is not recognised until declared, since even when highly predictable based on past experience, these are not obligations of the paying corporation until actually declared.
Furthermore, seasonality factors should not be smoothed out of the financial statements. For example, for many retail stores a high percentage of annual revenues occur during the holiday shopping period, and the quarterly or other interim financial statements should fully reflect such seasonality. That is, revenues should be recognised as they occur.
The fact that income taxes are assessed annually by the taxing authorities is the primary reason for reaching the conclusion 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, as discussed further below) 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. In other words, and as the standard puts it, the estimated average annual rate would “reflect a blend of the progressive tax rate structure expected to be applicable to the full year's earnings including enacted or substantially enacted changes in the income tax rates scheduled to take effect later in the financial year.”
IAS 34 addresses in detail the various computational aspects of an effective interim period tax rate, which are summarised in the following paragraphs.
Many entities are subject to a multiplicity of taxing jurisdictions, and in some instances the amount of income subject to tax will vary from one to the next, since different laws will include and exclude disparate items of income or expense from the tax base. For example, interest earned on government-issued bonds may be exempted from tax by the jurisdiction that issued them, but be defined as fully taxable by other tax jurisdictions the entity is subject to. To the extent feasible, the appropriate estimated average annual effective tax rate should be separately ascertained for each taxing jurisdiction and applied individually to the interim period pre-tax income of each jurisdiction, so that the most accurate estimate of income taxes can be developed at each interim reporting date. In general, an overall estimated effective tax rate will not be as satisfactory for this purpose as would a more carefully constructed set of estimated rates, since the pattern of taxable and deductible items will fluctuate from one period to the next.
Similarly, if the tax law prescribes different income tax rates for different categories of income (such as the tax rate on capital gains which usually differs from the tax rate applicable to business income in many countries), then to the extent practicable, a separate tax rate should be applied to each category of interim period pre-tax income. The standard, while mandating such detailed rules of computing and applying tax rates across jurisdictions or across categories of income, recognises that in practice such a degree of precision may not be achievable in all cases. Thus, in all such cases, IAS 34 softens its stand and allows usage of a “weighted-average of rates across jurisdictions or across categories of income” provided “it is a reasonable approximation of the effect of using more specific rates.”
In computing an expected effective tax rate for a given tax jurisdiction, all relevant features of the tax regulations should be taken into account. Jurisdictions may provide for tax credits based on new investment in plant and machinery, relocation of facilities to backward or underdeveloped areas, research and development expenditures, levels of export sales and so forth, and the expected credits against the tax for the full year should be given consideration in the determination of an expected effective tax rate. Thus, the tax effect of new investment in plant and machinery, when the local taxing body offers an investment credit for qualifying investment in tangible productive assets, will be reflected in those interim periods of the fiscal year in which the new investment occurs (assuming it can be forecast to occur later in a given fiscal year), and not merely in the period in which the new investment occurs. This is consistent with the underlying concept that taxes are strictly an annual phenomenon, but it is at variance with the purely discrete view of interim financial reporting.
IAS 34 notes that, although tax credits and similar modifying elements are to be taken into account in developing the expected effective tax rate to apply to interim earnings, tax benefits which will relate to onetime events are to be reflected in the interim period when those events take place. This is perhaps most likely to be encountered in the context of capital gains taxes incurred in connection with occasional dispositions of investments and other capital assets; since it is not feasible to project the rate at which such transactions will occur over the course of a year, the tax effects should be recognised only as the underlying events transpire.
While in most cases tax credits are to be handled as suggested in the foregoing paragraphs, in some jurisdictions tax credits, particularly those that relate to export revenue or capital expenditures, are in effect government grants. The accounting for government grants is set forth in IAS 20; in brief, grants are recognised in income over the period necessary to properly match them to the costs which the grants are intended to offset or defray. Thus, compliance with both IAS 20 and IAS 34 would necessitate that tax credits be carefully analysed to identify those which are, in substance, grants, and then accounting for the credit consistent with its true nature.
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 recognised immediately, but only if the criteria set forth in IAS 12 are met. Specifically, it must be deemed probable that the benefits will be realisable before the loss benefits can be given formal recognition in the financial statements. In the case of interim period losses, it may be necessary to assess not only whether the entity will be profitable enough in future fiscal years to utilise the tax benefits associated with the loss, but, furthermore, whether interim periods later in the same year will provide earnings of sufficient magnitude to absorb the losses of the current period.
IAS 12 provides that changes in expectations regarding the realisability of benefits related to net operating loss carryforwards should be reflected currently in tax expense. Similarly, if a net operating loss carryforward benefit is not deemed probable of being realised until the interim (or annual) period when it in fact becomes realised, the tax effect will be included in tax expense of that period. Appropriate explanatory material must be included in the notes to the financial statements, even on an interim basis, to provide the user with an understanding of the unusual relationship between pre-tax accounting income and the provision for income taxes.
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 logic is that the effective cost of materials, labour or other inputs will be altered later in the year as a consequence of the volume of activity during earlier interim periods, among others, and it would be a distortion of the reported results of those earlier periods if this were not taken into account. Clearly this must be based on estimates, since the volume of purchases, etc., in later portions of the year may not materialise as anticipated. As with other estimates, however, as more accurate information becomes available this will be adjusted on a prospective basis, meaning that the results of earlier periods should not be revised or corrected. This is consistent with the accounting prescribed for contingent rentals and is furthermore consistent with IAS 37's guidance on provisions.
The requirement to take volume rebates and similar adjustments into effect in interim period financial reporting applies equally to vendors or providers, as well as to customers or consumers of the goods and services. In both instances, however, it must be deemed probable that such adjustments have been earned or will occur before giving recognition to them in the financials. This high threshold has been set because the definitions of assets and liabilities in the IASB's Framework require that they be recognised only when it is probable that the benefits will flow into or out from the entity. Thus, accrual would only be appropriate for contractual price adjustments and related matters. Discretionary rebates and other price adjustments, even if typically experienced in earlier periods, would not be given formal recognition in the interim financials.
The rule regarding depreciation and amortisation in interim periods is more consistent with the discrete view of interim reporting. Charges to be recognised in the interim periods are to be related only to those assets actually employed during the period; planned acquisitions for later periods of the fiscal year are not to be taken into account.
While this rule seems entirely logical, it can give rise to a problem that is not encountered in the context of most other types of revenue or expense items. This occurs when the tax laws or financial reporting conventions permit or require that special allocation formulas be used during the year of acquisition (and often disposition) of an asset. In such cases, depreciation or amortisation will be an amount other than the amount that would be computed based purely on the fraction of the year the asset was in service. For example, assume that the convention is that one-half-year of depreciation is charged during the year the asset is acquired, irrespective of how many months it is in service. Further assume that a particular asset is acquired at the inception of the fourth quarter of the year. Under the requirements of IAS 34, the first three quarters would not be charged with any depreciation expense related to this asset (even if it was known in advance that the asset would be placed in service in the fourth quarter). However, this would then necessitate charging fourth quarter operations with one-half-year's (i.e., two quarters') depreciation, which arguably would distort that final period's results of operations.
IAS 34 does address this problem area. It states that an adjustment should be made in the final interim period so that the sum of interim depreciation and amortisation equals an independently computed annual charge for these items. However, since there is no requirement that financial statements be separately presented for a final interim period (and most entities, in fact, do not report for a final period), such an adjustment might be implicit in the annual financials, and presumably would be explained in the notes if material (the standard does not explicitly require this, however).
The alternative financial reporting strategy, that is, projecting annual depreciation, including the effect of asset dispositions and acquisitions planned for or reasonably anticipated to occur during the year, and then allocating this ratably to interim periods, has been rejected. Such an approach might have been rationalised in the same way that the use of the effective annual tax rate was in assigning tax expense or benefits to interim periods, but this has not been done.
Inventories represent a major category for most manufacturing and merchandising entities, and some inventory costing methods pose unique problems for interim financial reporting. In general, however, the same inventory costing principles should be utilised for interim reporting as for annual reporting. However, the use of estimates in determining quantities, costs and net realisable values at interim dates will be more pervasive.
Two particular difficulties are addressed in IAS 34. These are the matters of determining net realisable values at interim dates and the allocation of manufacturing variances.
Regarding net realisable value determination, the standard expresses the belief 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 which 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.
The last of the special issues related to inventories that are addressed by IAS 34 concerns allocation of variances at interim dates. When standard costing methods are employed, the resulting variances are typically allocated to cost of sales and inventories in proportion to the monetary magnitude of those two captions, or according to some other rational system. IAS 34 requires that the price, efficiency, spending and volume variances of a manufacturing entity are recognised in income at interim reporting dates to the extent those variances would be recognised at the end of the financial year. It should be noted that some national standards have prescribed deferral of such variances to year-end based on the premise that some of the variances will tend to offset over the course of a full fiscal year, particularly if the result of volume fluctuations is due to seasonal factors.
When variance allocation is thus deferred, the full balances of the variances are placed onto the statement of financial position, typically as additions to or deductions from the inventory accounts. However, IAS 34 expresses a preference that these variances be disposed of at interim dates (instead of being deferred to year-end) since to not do so could result in reporting inventory at interim dates at more or less than actual cost.
IAS 21 prescribes rules for translating the financial statements for foreign operations into either the functional currency or the presentation currency and also includes guidelines for using historical, average or closing foreign exchange rates. It also lays down rules for including the resulting adjustments either in income or in equity. IAS 34 requires that consistent with IAS 21, the actual average and closing rates for the interim period be used in translating financial statements of foreign operations at interim dates. In other words, the future changes to exchange rates (in the current financial year) are not allowed to be anticipated by IAS 34.
Where IAS 21 provides for translation adjustments to be recognised in the statement of profit or loss and other comprehensive income in the period it arises, 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.
While year-to-date financial reporting is not required, although the standard does recommend it in addition to normal interim period reporting, the concept finds some expression in the standard's position that adjustments not be made to earlier interim periods' results. 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.
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, when it is impracticable to determine the cumulative effect at the beginning of the financial year of applying a new accounting policy to all prior periods, adjusting the financial statements of prior interim periods of the current financial year, and comparable interim periods of prior financial years to apply the new accounting policy prospectively from the earliest date practicable.
One of the objectives of this requirement of IAS 34 is to ensure that a single accounting policy is applied to a particular class of transactions throughout the entire financial year. To allow differing accounting policies to be applied to the same class of transactions within a single financial year would be troublesome since it would result in “interim allocation difficulties, obscured operating results, and complicated analysis and understandability of interim period information.”
IAS 34 recognises that preparation of interim financial statements will require a greater use of estimates than annual financial statements. Appendix C to the standard provides examples of use of estimates to illustrate the application of this standard in this regard. The Appendix provides nine examples covering areas ranging from inventories to pensions. For instance, in the case of pensions, the Appendix states that for interim reporting purposes, reliable measurement is often obtainable by extrapolation of the latest actuarial valuation, as opposed to obtaining the same from a professionally qualified actuary, as would be expected at the end of a financial year. Readers are advised to read the other illustrations contained in Appendix C of IAS 34 for further guidance on the subject.
IAS 34 stipulated that an entity was to apply the same impairment testing, recognition and reversal criteria at an interim period as it would at the end of its financial year. The frequency of interim financial reporting, however, was not to affect the annual financial statements. This prescription created unanticipated conflicts, since certain impairments were not, according to other standards, subject to later reversals.
One apparent conflict between IAS 34's directives and the IAS 36 requirement is that an impairment loss recognised on goodwill cannot be later reversed. If, for example, an impairment of goodwill was indicated in the first fiscal quarter, but at year-end that impairment no longer existed, it would be impossible to comply with the proscription against having interim reporting affect annual results unless the impairment in the first quarter were reversed later in the year.
IFRIC Interpretation 10, Interim Financial Reporting and Impairment, directs that impairments of goodwill recognised in interim periods may not be later reversed, even if at year's end no impairment would otherwise have been reported. This interpretation therefore brings to an end the IAS 34-based mandate that the frequency of interim reporting cannot itself impact annual financial reporting.
IFRS 9, issued in October 2010, amended a number of paragraphs under IFRIC 10. The revision of IFRIC 10 states that entities may not reverse an impairment loss recognised in a previous interim period in respect of goodwill. However, this restriction will not extend to other areas of potential conflict between IAS 34 and other standards.
IAS 34 requires that interim financial reports in hyperinflationary economies be prepared using the same principles as at the financial year-end. Thus, the provisions of IAS 29 would need to be complied with in this regard. IAS 34 stipulates that in presenting interim data in the measuring unit, entities should report the resulting gain or loss on the net monetary position in the interim period's statement of comprehensive income. IAS 34 also requires that entities do not need to annualise the recognition of the gain or loss or use estimated annual inflation rates in preparing interim period financial statements in a hyperinflationary economy.
While both US GAAP and IFRS require interim reporting for public companies, there are significant differences with regard to how and when the elements of the financial statements are recognised and measured.
US GAAP requires that product-related or variable costs be recognised in full in the interim period as they are incurred, the same way that is required for annual financial statements. However, production cost allocation variances expected to be made up by the end of the period are deferred. Additionally, generally, practice and policies applied in annual periods shall be applied at interim periods. However, for other expenses, when the expenditure can be shown to clearly benefit a future period, the expense is allocated among those periods, resulting in deferral or accrual of certain costs. This is referred to as smoothing. Smoothing is done pursuant to the notion that an interim period is integral to the full fiscal period. IFRS regards each interim period as a discrete period. In other words under US GAAP, except for seasonal effects, each period should be predictive of the remaining periods of the fiscal year. Seasonal effects are disclosed. Entities are encouraged to present rolling full-year results for material seasonal effects if doing so would improve comparability. However, if an expense is unusual or cannot be reasonably attributed to future periods, it is not deferred. Allocations of these costs to current and future periods cannot be arbitrary. The effective income tax rate is based on full-year income estimates. Changes in income tax rates are recognised in the current interim period, unless attributed to an error.
US GAAP is more explicit about the types of transactions that require disclosures related to fourth-quarter activity. In particular, the following fourth-quarter activity must be disclosed:
US GAAP, unlike IFRS, does not allow decreases in inventory value recorded in annual financial statements to be reversed. However, for interim reporting, if the price of inventory rises in a subsequent interim period within the same fiscal year, a reversal gain is recognised up to the amount of previous losses. The LIFO method of inventory cost flow is prohibited under IFRS, but not under US GAAP. When a LIFO-layer liquidation is expected to be restored by the end of the year, a debit to inventory is made with an offset to current liabilities in the interim period and replacement costs of the inventory are recognised in cost of goods sold.
Materiality of an adjustment is determined with regard to the expected results for the fiscal year. IFRS uses the current interim period results. Similar to IFRS, costs that are accrued during the year because the amount is based on full-year activities (e.g., sales and purchase discounts, bonuses) are estimated and recognised at each interim period.
Under US GAAP, a statement of Changes in Equity is not required in interim financial statements.