In this article we will discuss about Interim Reporting:- 1. Need for Interim Reporting 2. SEBI’S Guidelines on Interim Reporting 3. Problems 4. Interim Reporting Practices in India.
Need for Interim Reporting:
In a dynamic business environment, with the increased scope and complexity of business enterprises, annual data are insufficient to evaluate developments in general economic, industry, and company activities and making or revising projections of earnings and financial position as a basis for investments decisions.
Investment decisions are made on the basis of information disclosed in company annual reports. These economic decisions are made throughout the year rather than at year-end reporting dates. Although annual reporting has been accepted by accountants and/or law, investment decisions based on financial data are made daily and require current financial information.
No doubt the annual report will continue as a report on management’s stewardship for the full year and a benchmark for measurement of financial progress over several years. But neither the dynamics of the internal organisation, nor outside economic forces stop and start over at each new accounting year.
Therefore, it is suggested that company financial reporting should continuously measure and report on the firm’s progress and provide information on a less than annual basis for the benefit of shareholders and other external users.
An important research study by Setoff concludes:
“Interim income numbers are the important ones and the annual income number provides merely a confirmation of the previously reported numbers. The central thrust for the development of accounting reporting standards should be directed to interim reporting and modification in annual reporting standards should be made to accommodate the interim period. The interim period is a fraction of the annual period, much as the annual period is a fraction of the entity’s life. The problem of integral vs. discrete is, therefore, viewed as a non-problem…”
The FASB’s (USA) Discussion Memorandum has found the following five possible objectives and uses for interim reporting:
1. To estimate annual earnings.
2. To make projections.
3. To identify turning points.
4. To evaluate management performance.
5. To supplement the annual report.
Accounting Standards (AS-25), ‘Interim Financial Reporting’ issued by ICAI in February 2002 observes:
“Timely and reliable interim financial reporting improves the ability of investors, creditors and others to understand an enterprise’s capacity, to generate earnings and cash flows, its financial condition and liquidity.”
AS-25 comes into effect in respect of accounting periods commencing on or after April 1, 2002. The objectives of AS-25 is to prescribe the minimum content of an interim financial report and to prescribe the principles for recognition and measurement in a complete or condensed financial statements for an interim period.
SEBI’S Guidelines on Interim Reporting:
Based on the Bhave Committee’s recommendations, the SEBI issued the guidelines on February 4, 2000 requiring the stock exchanges to amend the listing agreements to incorporate quarterly financial reporting.
The main features of SEBI’s guidelines are as follows:
(1) A company should furnish unaudited financial result on a quarterly basis in the prescribed proforma within one month of the expiry of the period to the Stock Exchange and will make an announcement forthwith to the Stock Exchanges where the company is listed and also within 48 hours of the conclusion of the Board Meeting at least in one English daily newspaper circulating in the whole or substantially the whole of India and in a newspaper published in the language of the region, where the registered office of the company is situated.
(2) The Board of Directors should take on record the unaudited quarterly results which shall be signed by the Managing Director/Director. The Company shall inform the Stock Exchange where its securities are listed about the date of the aforesaid Board Meeting at least 7 days in advance and shall also issue immediately a press release in at least one national newspaper and one regional language newspaper about the date of the aforesaid Board Meeting.
(3) The unaudited result should not differ substantially from the audited result of the company. If the sum of four quarters as regards any items differs more than 20 per cent when compared to its full year figure, the company shall explain the reason of such variance.
(4) In addition, a company has to prepare half yearly results in the same proforma. The half yearly results are subject to limited audit review by the auditors of the company. The meaning and scope of the limited audited review is not explained. The limited audit review report should be submitted to the stock exchange within two months after the close of the half year.
(5) If the sum of the first and second quarterly unaudited results in respect of any item given in the same proforma format varies 20 per cent or more from the respective half yearly results as determined after limited audit review, the company has to prepare statement explaining reasons thereof. Such an explanatory statement should be approved by the Board of Directors and should be submitted to the Stock Exchange along with the Limited Audit Review Report.
(6) If a company intimates the stock exchange in advance that it will publish its audited result within a period of three months from the end of the financial year, then there is no need to publish the results of the last quarter.
Notes attached to the Specimen Quarterly Financial Reporting format further require that:
(a) Any material event or transaction like strike, completion of diversification or expansion programme, which have material impact in understanding quarterly result should be separately disclosed. Any such material event or transaction which occurred subsequent to the end of the quarter and the effect of which is not reflected in the quarterly results should also be disclosed.
(b) Items of non-recurring or abnormal items of gain/loss should be disclosed separately.
(c) Effect of changes in accounting policies should be disclosed separately.
(d) In case of companies whose revenues are subject to seasonal variations, it is necessary to provide financial results for a period of twelve months ending on the last day of the quarter for the current and preceding years on a rolling basis.
(e) Dividend information.
(f) Effect of change in the composition of the company during the quarter. Such changes may occur because of acquisition, or disposal of subsidiaries, business combination or restructuring.
(g) It is necessary to disclose the audit qualification, if any, on the previous year’s accounts along with the quarterly results. It should also give explanation as to how such qualifications has been addressed in the unaudited financial results.
(h) The company, which is yet to commence commercial production, should give particulars about the status of the project, its implementation and expected date of commissioning. This should be given in lieu of the quarterly results.
(i) The unaudited results should be prepared on the basis of same set of accounting policies which have been followed in the preparation of the financial statements of the previous year. In case there is a change in the accounting policy, the result of the previous year should be recast to make it comparable with the current year’s result.
The SEBI’s other provisions on interim financial reporting are as follows:
(i) Statement of Variations between Projected Fund Utilisation and Profitability:
The SEBI has further improved the quarterly report including a statement of variations between projected and actual utilization of funds and profitability of a company. Companies project its fund utilization and profitability in the prospectus or offer letter while raising funds and subsequently validity of such projections are not assessed.
It is required that listed companies should furnish on quarterly basis a statement to the exchange indicating the variations between projected and actual utilization of funds and profitability.
The statement should include information as regards projections given in each year. It should be published along with audited and unaudited results. It is necessary to provide an explanation in case the variation is material. This explanation should also be included in the Director’s Report.
(ii) Enforcement of Corporate Governance:
The SEBI also required to submit quarterly compliance report on the corporate governance.
(iii) Option to publish audited half yearly results:
A listed company has the option to publish audited half yearly results within two months from the end of the half year along with the limited audit review instead of publishing unaudited quarterly results.
(iv) Disclosure of non-promoter shareholding in the half yearly financial results:
A listed company is required to furnish aggregate non-promoter shareholding in half yearly results commencing from the half year ended on or after March 31, 2001.
(v) Quarterly Disclosure of Companies which are yet to commence commercial production:
These companies are required to make additional disclosure about the unutilized amount of monies raised and form of investment of such amount.
(vi) Quarterly Segment Report:
Companies are required to furnish quarterly segment report in the prescribed format in respect of all the companies including companies whose accounting year has commenced before April 01, 2001, segment information prescribed under clause 41 shall be given for the quarters ending on or after September 30, 2001.
(vii) Compliance with accounting for taxes on income:
Companies are required to follow accounting standard on “Accounting for Taxes on Income” in respect of the quarterly unaudited financial results with effect from the quarters ending on and from September 30, 2001.
(viii) Optional Quarterly Consolidated Financial Results:
A parent company may publish consolidated quarterly financial results in addition to its own quarterly financial results.
Problems in Interim Reporting:
Estimates and judgements are required for determining results of operations for any period, even a whole year. Normally, though, the shorter the period, the less precise the results, because the relative importance of estimates and judgments increases as the materiality base—e.g., the reported amounts—decreases.
Further, to develop interim results, companies must rely more heavily on estimates. Of course, the more sophisticated a company’s accounting system and the stronger its internal control, the less it needs to rely on estimates. Basically two problems— Accounting Problems and Conceptual Problems are involved in interim financial reporting.
Accounting Problems are of the following types:
1. Inventory Problems:
In a business enterprise, inventory is a major element in the generation of income. Inventory problem in interim reporting has three types of problems: determination of inventory quantity, valuation of inventories, and adjustments of valuation. The development of inventory data for interim reporting depends largely on the making of accurate physical counts and its costing procedure.
However, the valuation problem is more important than the quantity problem. It is almost invariably considered impractical to count and price the inventory every quarter or every month, so estimates of gross profit must be used to determine cost of goods sold.
Alternatively, the company may have perpetual inventory records integrated with the accounting records, allowing direct determination of cost of goods sold, but the perpetual records may not be verified by cycle counts, and some interim allowance will be needed for annual physical inventory adjustments.
The inventory problem is further complicated for companies on LIFO, since these companies must estimate not only the gross profit on their sales but also the effect of inflation and the year- end inventory quantity level.
It is said that for business firms adopting LIFO, interim reports may be a problem if the inventory level at the end of the reporting period is below than at the beginning of the year. In such situations, interim periods are not independent of other reporting periods. Inventory valuations are further adjusted to lower-of-cost or market value.
2. Matching Problem:
Business operations are not similar and uniform throughout the year. Resources are acquired and output is done in advance of sales. Some costs related to current sales do not mature into liabilities or readily measurable expenses until a subsequent time.
Because of various lead and lag relationships between cost and sales, difficulties are crated in matching costs and revenues. The relationship between costs and revenues becomes unclear.
Interim accruals for various selling expenses, general and administrative expenses, allowances for doubtful accounts, and deferrals and contingencies are illustrations of items that normally require companies to rely heavily on estimates.
Many techniques and procedures are available in accounting for allocating cost between different periods. But the allocation procedures appear to be highly arbitrary which raise serious questions as to the reliability and usefulness of the results.
For example, depreciation and property taxes may be allocated to months on a time basis, but deducting a constant amount each period when sales fluctuate, tend to increase the amplitude of fluctuations in reported profits.
Some expenses to be incurred during a period may be uncertain at the time when revenues are reported, e.g., maintenance and repairs, employee vacations, various taxes, etc. Income-tax is also a complex area in interim reporting requiring considerable attention. In order to calculate interim income taxes, a company must estimate such items as the annual pre-tax income, and other permanent differences for the full year.
Because investors have a tendency to project a full year’s results on the basis of data given for the short period, random fluctuations or seasonal business that occurs in short periods, if not recognized, would lead to erroneous projections.
Seasonal business also raises a question about matching revenues and expenses during the year. When revenue are combined to a short season and direct costs are incurred throughout the year, is it appropriate to spread these costs proportionate to revenues.
3. Extent of Disclosure Problem:
There is a problem of deciding the quantity of disclosure in interim financial reports. Generally speaking, disclosure requirements applicable for annual reporting are not applicable to interim reporting. In the absence of mandatory interim disclosure, the interim disclosure practices are likely to vary.
There is a problem of determining materiality criteria for deciding the information to be disclosed in interim reports. The treatment to be given in respect of prior period adjustments, extraordinary items and earning per share can create difficulties in interim reporting.
Interim reporting restricts the quality of accounting measurements. Also, disclosures in addition to the basic financial statements often cannot be fully developed and thus interim disclosures become limited in comparison with annual disclosures. But users are likely to consider the opportunity loss caused by delay in receipt of current financial information than the benefit of more detailed, accurate information received later.
The primary conceptual issue is whether the interim period is part of a longer period or is a period in itself. The former position is known as the integral view, the latter as the discrete view. Under the integral view, revenue and expenses for interim periods are based on estimates of total annual revenues and expenses.
The discrete view holds that earnings for each period are not affected by projections of the annual results; the methods used to measure earnings are the same for any period, whether a quarter or a year. As a practical matter, some elements of both positions are recognised in current reporting.
In both accounting theory and practice, there are currently two opposing viewpoints of the problem of interim financial reporting. Those who favour the first, the discrete approach, view “each interim period as a basic accounting period and conclude that the results of operations for each interim period should be determined in essentially the same manner as if the interim period were an annual accounting period”.
Those who favour the second, the integral approach, view each interim period primarily as being an integral part of the annual period. Under this view deferrals, accruals, and estimates at the end of each interim period are affected by judgments made at the interim date as to the results of operations for the balance of the annual period.
Proponents of the discrete approach, on the other hand, argue that users are interested in a report of the actual realizations of the interim period itself in order to monitor management’s (and the firm’s) performance during this period.
Consequently, they argue against any allocation of costs based upon annual results that would lead to a ‘smoothing’ effect in which turning points and short-term fluctuations are obscured from investors.
In addition, while the usefulness of interim reports in making future projections is acknowledged, it is argued “the estimating period may, but need not, coincide with an annual fiscal period….users should be free to make their own choices of forecasting period”. Thus, proponents of the discrete approach argue for similar treatment of interim and annual reports.
Proponents of the integral approach argue that the primary purpose of interim reports is to aid users in forecasting the future, with emphasis on the estimation of annual results. Interim reports, therefore, should be affected by one’s expectations of annual operations.
In a study conducted by Schiff, it was found that financial executives prefer discrete approach for some issues, whereas the integral view was favoured for others (issues). This combination view was explicitly recognised as a third alternative to the first two basic approaches by the Financial Accounting Standards Board (USA) in its Discussion Memorandum entitled ‘Interim Financial Accounting and Reporting’.
The FASB justifies the combination approach by stating:
“Users may be interested both in making predictions for various future periods and in detecting changes in profit trend and liquidity. It may not be necessary….to place emphasis on one of these or on other possible uses. The integral and discrete views may be seen to have both advantages and disadvantages. Therefore a more reasoned approach is to attempt to obtain the advantages and minimise the disadvantages of each of these views.”
Fried and Livnot, in their recent study, however, have concluded that the ranking of the accounting methods (discrete, or integral, or combination) for the various objectives of interim reporting depended to a great degree on the nature of the environment and the specific conditions of uncertainty and correlations of the periodic cash flows.
Critics of integral basis suggest that essential judgments and allocations can sometimes be used artificially to smooth over and disguise significant operating changes. So called ‘discrete’ interim period reporting appears to avoid many of these problems of estimation and allocation in apportioning expected annual figures.
Most companies, therefore, seem to follow the discrete principal in practice. Exceptional expenditure is borne as it occurs, or noted separately as being omitted for subsequent treatment in the annual financial statements. Often no account is taken of tax adjustments expected on the year’s results.
In such cases, the interim figures will usually be accompanied by a narrative explanation of the policies adopted. The discrete approach, however, contains few clues to management’s expectations for the rest of the year, and may reduce for users the inherent predictive implications of interim reporting, unless supplemented by more detailed narratives on expected events and the prospects for the whole year.
The discrete basis tends to cause greater fluctuations from period to period, which can sometimes mislead, but some believe this highlights real business turning points.
The SEC (USA) has argued that it is in isolating these turning points that interim reports can be most useful by modifying the smoothing inadequacies of annual statements. It is difficult, however, to distinguish a real turning point from a regular trading fluctuation, and this is nowhere more accurate than in seasonal businesses.
Interim Reporting Practices in India:
In India, companies whose securities are listed on stock exchanges are required to report quarterly unaudited financial result pursuant to the listing requirements. Fig 14.1 and Fig 14.2 display quarterly unaudited financial results of two Indian companies as published by them in the national newspaper.