Definition and explanation
The time period assumption (also known as periodicity assumption and accounting time period concept) states that the life of a business can be divided into equal time periods. These time periods are known as accounting periods for which companies prepare their financial statements to be used by various internal and external parties and stakeholders.
The length of accounting period to be used for the preparation of financial statements depends on the nature and requirement of each business as well as the need of the users of financial statements. Normally, an accounting period consists of a quarter, six months or a year depending on the needs of business entity and its stakeholders.
Importance of time period assumption
The time period assumption enables business organizations to stop and see how successful they have been in achieving their objectives during a particular period of time and where the room for improvement exists.
The users of financial statements need current and reliable information to evaluate financial performance and position of the companies to make important decisions and take appropriate actions. The time period assumption enables companies to divide their economic activities into short time periods. For each time period, companies prepare and publish a set of financial statements to meet the needs of the users of financial statements. The time period for which a financial statement is prepared is shown in its heading.
The income statement tells interested parties how profitably the company has carried out its operations during the period and balance sheet discloses the financial position of the business at the end of the period. The statement of cash flows shows the reasons of inflows and outflows of cash and cash equivalents during the period and statement of retained earnings tells what portion of the company’s profit has been distributed among its owners and what portion has been kept in the business for future growth and for other purposes like meeting debt obligations etc.
This information is very important for internal management, actual and potential investors, creditors, government agencies and other users of financial statements to decide what to do and what not to do in future. The time period assumption facilitates the provision of latest, relevant and reliable financial information to the relevant parties to make reliable business decisions in a timely manner.
The Meta company provides services valuing $2,500 to Beta company during the first quarter of the year. The Beta company will pay the cash for these services next quarter. According to time period assumption, if Meta company prepares its financial statements at the end of the first quarter of the year, it must include this service revenue of $2,500 in its income statement for the first quarter.
The Meta company incurs expenses of $1,200 during the first quarter of the year. The cash for these expenses will be paid next quarter. The time period assumption requires Meta company to disclose these expenses on the income statement for the first quarter of the year.