 and welcome to this session. This is Professor Farhad and this session we would look at interim reporting. This topic is covered in advanced accounting and surely covered on the CPA exam. As always, I would like to remind you to connect with me on LinkedIn and please subscribe to my YouTube channel. YouTube is where I house over 1500 plus accounting, audit, and tax lectures. Please like my lectures if you like them, share them, put them in playlists. If you're benefiting from them, it means other people might benefit as well. This is my Instagram account. This is my Facebook account. I do have a few premium recording on Gumroad and I do have a website. You want to make sure you visit my website because on my website, I always have offers, especially for CPA and accounting students. Right now, Becker is running a limited time offer with unlimited access to the best CPA course out there. Becker, this is unusual because usually Becker never had unlimited offer before. I strongly suggest if you're studying for your CPA, that's the best course you can have. Also, if you're an accounting student, it doesn't hurt to sign up for it because it has unlimited access. You could use the course to supplement your college studies. Let's talk about interim reporting. The first thing is we talk about what's the big idea. The big idea about interim reporting is something called the periodicity principle. What is that periodicity principle? You should have learned about that principle in financial accounting 101. Basically, the periodicity principle state that the life of the company is broken down into artificial period. For example, let me just let's do it quarterly. One, two, three, four. One, two, three, four. The life of the company is broken into four periods, usually not usually publicly traded companies. They have to prepare their financial statements on a quarterly basis. This quarterly basis, which is not a complete year, this partial year is called interim reporting. It's a reporting period that's less than a year. Interim financial statements are presented to provide information about the financial status and progress for time period for less than a year, because once we have a full year, then we issue our annual report. The normal time period is a quarter of a year. It's prepared for the most recent interim period as well as on a cumulative basis. So when you get to Q2, you would report Q2 plus Q1 and Q2. So the numbers would include both. And you will prepare financial statements such as income statement, balance sheet, cash flow, statements of shareholders equity. Basically, statements that you would prepare on an annual basis, but they are on a quarterly basis. Now, if you're a publicly traded company, the SEC requires public companies to file their 10Q. Q is for a quarter. Don't confuse 10Q with 10K, which is the annual. Those statements, the 10Qs are reviewed. The 10Qs are reviewed. That means they, the auditor or the preparer of the financial statements, well, the auditors, they perform inquiries, analytical procedures, financial ratios. The point is they are not audited. They are not audited inquiries, not inquired inquiries. You perform inquiries. What is the problem with interim reporting? Well, it's not a complete year. And for some businesses, the nature of the business could be seasonal. So what does it mean seasonal? Let's look at a ski business. In a ski business, if you look at the revenues, the revenues would look like this if it's on a yearly timeframe. For example, if this is the year, if this is January till December, well, it's going to look, it's going to look high in January, then it's going to start to go down. It's going to, this is a spike here, a necessary spike. So the revenues will be high, then it's going to, you know, close to zero. Then by the end of the year, it will go up again because it's the ski season. So notice it's seasonal. So if you break down their company into quarters, well, in some quarters, you're going to have a lot of revenues and non quarters, not a lot of revenues. And the same thing with expenses. So that's one of the problem. So what's your accounting method we should use? How should you account for this for the short period? Well, there's two, basically two methods, two, or two kind of two theories, but there are two methods. Okay. One method says that accountant should hold each interim period as a standalone discreet view. This is called the discreet view. Well, what does that mean? It's mean the quarter is independent. So what you do at the end of the quarter, you adjust for revenues, for expenses, as if it's the end of the year, although it's the end of the quarter. Okay. The other method is the interim period is essentially an integral part of the annual report. So this period is only a part of the annual report. So you, when you are performing, when you are preparing your financial statements, you should take everything into consideration for the whole year. For example, you allocate your expenses. For example, if you paid your advertising expense, you would say, well, this advertising expense for the whole year, therefore I would allocate it. The depreciation is for the whole year, so on and so forth. Now in practice, there's some vagueness in this area or some vagueness in which method you can use, because for some expenses, you can use the integral part and some you could use the standalone. So just bear in mind that there is some vagueness in this issue. Now the board conclude that's basically the decision that each period should be viewed as an integral part that sometime for some items you might have to use a standalone. Okay. So financial statements for each period should be based on the accounting practices used for the whole year. Of course, you cannot use different accounting practices, different accounting method. You have to use the same method. For example, for revenues, if you're using the percentage of completion method, you have to use the percentage of completion method for the quarter as well as for the whole year. So you cannot switch method. And any cost associated with revenue should be treated the same for the interim period. For example, how you would account for labor, material overhead, you should be using the same method as far as revenue and any related expenses associated with that revenue directly associated. Inventory. Well, there are acceptable alternative method for inventory. For example, cost of goods sold can be estimated using the gross profit percentage. So you don't have to compute, you don't have to count your inventory by the end of the quarter. You could use the gross profit method. If you don't know what the gross profit method is, it's just a way to estimate ending inventory in order to determine cost of goods sold. Now, although we'd use the gross profit for the quarterly, you would have to disclose, you know, what did you do and reconcile this method for the end of the year. Liquidated life for base should be charged at replacement costs if expected to be replaced by the end of the year. So simply put, if you have a life for liquidation, don't account for life for liquidation unless you are not replacing. But if you are going to be replacing life for liquidation, so it's not going to appear, then there is no need to account for life of life for liquidation that occurred. So it's useless work. If you're going to do it during the quarter by the end of the year, you replace your life, you replace your inventory, then don't do it. Now you might be saying, what is life for liquidation? What is that? Well, if you don't know what life for liquidation is, go to my Intermediate Accounting Chapter 9. Intermediate Accounting Chapter 9 will talk about life for liquidation, just in case you are not familiar with inventory or the gross profit method. Inventory loss from market decline expected to be recovered before the end of the year should not be recognized. Same concept for life for liquidation. Remember, we have to report inventory at lower of cost or net realizable value. This used to be LCM, lower of cost or market. Now we say lower of cost or net realizable value. But if you think your inventory is going to recover by the end of the year, let's assume this is second, third, and fourth quarter, you experience decline in your inventory here. Don't book it if you think by the fourth quarter it's going to recover because it's useless work. You're going to write it down, then if it's going to be written up, why did you write it down if it's going to be written up? Now if it's going to be down till the end of the quarter, till the end of the year, then you would write it down. But don't do it. Basically, in a sense, you will do the work, then you reverse it. Standard cost for determining inventory should be based on the procedure used for the same year. So whatever standard cost you are using, you would use the same cost. What about cost other than product cost, such as period cost, expenses for the headquarter, for the payroll, for HR? You charge the income as incurred based on estimated time expired. For example, if there's a time expired associated with that expense or benefit received, is it benefiting this period? That period cost? You expense it? Or activity associated? Is it when we perform an activity? Is it being expensed? Time expired, think about depreciation. For example, if you're doing straight line, you just divide the straight line by four. Now, if not readily identified with an activity or a benefit, it should be recognized when incurred. So you cannot identify it with an activity, you cannot identify it with a certain benefit, then and you cannot do a time expired, you cannot allocate it over a period of time reasonably. So what you do is when you when you incurred that expense, you would just charge it to expense. You should not do arbitrary assignments. Okay, so basically take the expense and spread it out annually. First, see if you can allocate it to something activity time period benefits, also gains and losses that would not be deferred at the end of the year should not be deferred at the interim period. So if you have any gain or losses, and you know those gain and losses will not be deferred by the end of the year, then you would you would not defer them, you would count them during the quarter. Okay, there are other issues that kind of kind of you have more than one option, for example, advertising and similar costs. Think about advertising. When you advertise, when you spend money, let's just look at it from a quarterly perspective, one, two, three, four, let's assume you spend some money here in the second quarter on advertising. Well, you spend, you know, $300,000. Well, this $300,000, is it only benefiting this quarter, or is it benefiting the third, the fourth, and maybe into the following year? You really don't know because no one knows the benefit of advertising, right? You don't know the future benefit of it. Okay, so the general guidelines are that companies should defer interim period costs, such as advertising, if it benefit extended extended period beyond that period. Now, how would you know? Okay, you really don't know. Sometimes you just have to make a decision. I don't think it's going to benefit or I think it's benefit. Okay, if you don't think it's going to benefit, you will expense them. Okay, so there's a vagueness in this area, so just want to make sure you are aware of this. Okay, for example, some companies, such as Nabisco, church advertising is a percentage of sales, then they will adjust it at year end. Okay, so what they say is the more we sell, the more we expense and advertising because they are related to each other. General food and Kellogg, they expense the cost as they incur. As soon as they incur them, they just expense it. Okay, also the same type of problem would occur for social security taxes. For example, you have an executive that's making a lot of money in the first quarter. Okay, so one, two, three, four. So this executive by the first, but by the end of the first quarter, they might have made $140,000. The reason I selected 140 because I know it's more than the social security tax now. So at this time, at this time, they paid older social security tax. But guess what? This social security tax is for the whole year. Okay, but they paid it during the first quarter. So what do you do? Do you expense it there or do you spread it? Same thing for research and development, like same concept with advertising. How do you know how many periods it's going to benefit and how should you allocate it? The same concept would apply to major repairs because it applies to more than one period. Okay, for example, should the company expense social security on a highly paid personnel early in the year or allocate and spread them to subsequent period? Okay, again, here the company will have to decide should a major repair that occur later in the year be anticipated and allocated proportionally? Should you do that? Or should you connect it to one period? Okay, other expenses that are subject to year and adjustments. For example, that debt. How should you book the bad debt? Should you wait till the end of the year or you should you book it on a quarterly basis? Well, you can do it on a quarterly basis then adjust it. Executive bonuses you really don't know, pension costs, those are all estimate. So what should you do? You should estimate these costs and allocate them the best you can because those are just estimates in the first place. Okay, and you could use a variety of allocation technique. So how you do it, it's up to you. Okay, income tax. And for income tax we'll work an example because it's interesting. It basically it involves two type of two type of discipline financial accounting and taxes. So we'll look at an example. The profession uses the annualized approach. Now, what is the annualized approach? It means at the end of the period, at the end of the interim period, the company should make the best estimate of the effective tax rate. So you have to compute the effective tax rate expected to be applicable. So what's my effective tax rate? And the effective is, you know, how much actually am I going to end up paying? You're going to have to estimate this number. Okay, so the rate, the rate so determined should be used in providing for income taxes on the for the quarter. So this is what you would do for the quarter. So you'd have to estimate. Now, how would you estimate the best way to illustrate this is to actually work an example. So let's take a look at this company, just kind of show you how this whole picture fits together. And we're going to be giving actual earning for the first two quarters and the estimated during the year. So the company basically, they can estimate, they can estimate their earning. This is their actual first quarter earnings. So this is during the first quarter. And that's their actual, they made $400,000. Their actual second quarter is 510. Okay, this is their earnings. First quarter estimate of annual earning $1,350,000. So they think for the whole year, based on their first, on their first estimate, based on the first quarter, they estimate the revenue to be $1,350,000. By the time they get to the second quarter, they find out that, yeah, they're doing better. Therefore, their estimated earning by the second quarter, it should be $1,420,000. Now, why did they increase this? Well, their salespeople told them, you know, we are selling more than what we expected. Therefore, we're going to up our estimate, up our earning estimate. Okay. So also, the company estimated its permanent differences between accounting income and taxable income. So this is now we're getting into taxation. Environmental violation penalties $25,000 and dividend income execution $180,000. Now, if you don't know what these are, like, what is he talking about, why are we including this or when I can perform the computation, you have to go to my income tax course. Okay, go to my channel, go to my website, go to my channel, and you can find, you know, you could learn about income tax course. So simply put, how are we going to estimate the first quarter taxes? So let's do it quarter by quarter. Here's what we do. First, we'd say this is our first quarter estimate of annual earnings. So let's start with this number. This is what we estimate to earn. Now, we are computing our taxes. Now, bear in mind, we have to add back the $25,000 because the $25,000 is not deductible because it's a violation penalties. Violation penalties are not deductible. Then we have to deduct the dividend income execution because they do give us a deduction for that. And if you don't know what this is, this is called the dividend receive deduction, DRD. Again, you have to know taxes here. That's going to give us our estimated annual estimated taxable income. And this is going to be $1,195,000. This is our estimate of taxable income. This is how much we estimate. This is how much we estimate. Now, based on this estimate, we can compute our income tax based on the rate. And the rate is 42%. Here we go. The rate is given. You have to know what your rate is. Your rate is 42%. That's your rate. So if you take $1,195,000 multiplied by 42%, $5,01,900. So this is your estimate annual income taxes payable. This is the estimate. This is how much you think you are going to pay based on your estimate income, your estimate income of $1,320,000. This is all estimate. Now we need to compute the effective. Well, what is the effective? So the effective is, I'm going to have to pay $5,01,000. If you're saying I'm going to have to pay $5,01,900 based on your best estimate, based on $1,350,000 of earnings, okay, $1,350,000 in earning, then my effective rate is 37.2%. Well, if this is my effective, if this is my effective, and I made $400,000 for the first quarter, times 37.2%. Therefore, my taxes should be $148,800 debit income tax expense, credit income taxes payable. So first, I needed to find out what's my effective. So I looked at my estimate, my annual estimate, and I figured out what's my estimated taxable income. Then I multiplied by 42%. This is my estimate taxes. So I took my estimate taxes divided by estimated revenue. My effective should be 37. Well, if it's 37 and I made $400,000, then I have to book $148,800. And this is the computation in detail plus the journal entry in case, you know, you missed something from my computation, okay. Now, we're going to do the same thing for the second quarter. We're going to do the same thing for the second quarter. So the second quarter, our estimate annual earning is $1,420,000. Basically, we increased our estimate. I guess we're doing good. Then we subtract $180,000, add the subtract $180,000, add the $25,000. So we need to subtract $180,000, and add $25,000. We need to subtract $155,000. Remember, the $180,000 is for the dividend received deduction, and the $25,000 is for the penalty, because we cannot deduct the penalty. We have to add it back, but we can deduct the dividend received deduction. Therefore, the net is $155,000. So this is the net. The net is $155,000, okay. So $155,000. So your estimated taxable income is $1,265,000. Well, if I take this number, $1,265,000 times 42%, I will have an estimated taxes now, $531,000. Notice, my estimated taxes were $5,000 or $1,900 earlier. Well, I'm going to be making more money. I estimate to pay more taxes. I will do the same thing. I will take my, what should be my estimate taxes divided my estimate earnings, and my rate now is $37.4. It makes sense. It's higher. The more money you make, the more taxes you pay, 37.4%. Now, I'm doing this, but bear in mind that now the, it's a little bit easier because there's a flat tax rate now of 21%, okay. So just, this is for illustration purposes, but basically the tax rate do change, and now there's a flat rate. So it's a little bit easier because the rate, in a sense, the same, okay. Now, your cumulative income tax, now what's your cumulative income tax? Well, cumulative, I'm sorry, not cumulative income to date, you made $400,000 first quarter, $510,000 the second quarter, you made so far $910,000. Now, you're going to multiply this by 37.4% because this is your estimated effective. So your taxes should be up to the second quarter, $340,000, $340,000, $340,000. This is your cumulative. Cumulative means this is your quarter, this is your first quarter taxes, plus you set your second quarter taxes based on the estimate. So guess what, you already recorded $148,800, therefore what left for the second quarter to book $191,540. And this is maybe this picture will illustrate the concept for you. So you'll debit income tax expense, credit income tax is payable for $191,500. And this is what happened, those are your four quarters, in the first quarter we booked $148,800, and by the second quarter we find out we should be at $340,000, $340,000, $340,000, therefore our second quarter taxes were $191,540. Basically it's the, if we need to end up with $340,000, $340,000, we are at the booked $148,000, well $195,000 is what's needed for the second quarter. And we'll do the same thing for the third quarter. By the third quarter we might have increased the estimate annual earning or reduced it, we'll follow the same steps. Adding changes in interim period, if you have a change in estimate accounted for as an interim period when the change is made, you change as your depreciation, you change as any type of estimate you did, depreciation is a form of estimate bet that expense warranty, no restatement of prior period, prior interim period, and the effect of earning disclose on the current and subsequent period. And you have to disclose that you have a change in estimate obviously and the effect of the on the current and subsequent period. Now would you have to go back and change any numbers? If it's practical and easy you might be able to, but otherwise change in estimate is treated prospectively. Now if you don't know how to deal with change in estimate, change in accounting principle, go to my intermediate accounting chapter 22 because this is what this topic specifically entails. Minimum disclosure and interim report, what do you need to disclose? Basically now this is a list of laundry, gross revenue provisions for income taxes, there is no more extraordinary item, basic and diluted earnings per share, you have to show the basic and the diluted seasonal revenue cost or expense, just explain the seasonal revenue, how is it seasonal significant changes in estimate, we just talked about this or provision for income taxes, if there's any changes in the provision of income taxes and we looked at it and there was some changes in the income tax effective rate. Disposal of a segment of a business, there's no more extraordinary, contingent items, any contingent item changes in accounting principle or estimate, again changes in estimate, significant change in financial position and any other relevant information that you think is relevant for the users. If you have any questions about this topic please email me, if you happen to visit my website for additional lectures please consider donating, if you happen to visit my CPA, if you are studying for the CPA exam as always study hard, it's worth it and see you on the other side of success.