Accounting period: What is it?

Definition

An accounting period, also referred to as a fiscal period or financial period, is a defined span of time during which a business records its financial transactions and prepares financial statements.

What is an accounting period?

This period serves as the basis for reporting the organisation’s financial performance and position. The duration of an accounting period can vary and is typically chosen based on the specific needs and practices of the business. Common periods include a month, a quarter, or a year.

The primary reason for establishing an accounting period is to systematically organise financial data, enabling accurate and meaningful presentation of a business’s economic activities. Financial statements, such as the income statement, balance sheet, and cash flow statement, are generated at the conclusion of each accounting period. These statements offer a consolidated view of revenue, expenses, assets, liabilities, and cash flows during the specified timeframe.

Beyond financial reporting, accounting periods play an important role in budgeting and planning. Businesses align their budgets with specific periods to monitor and evaluate performance against predetermined expectations. For tax reporting, it’s usually necessary to follow a specific accounting period that lines up with the fiscal year.

Accounting principles

Accounting periods are essential for reporting and analysis, aiming to demonstrate stability and long-term profitability over time. The accrual method of accounting supports this by recording transactions when they occur, regardless of when cash changes hands. For instance, it spreads the expense of a fixed asset’s depreciation across its useful life, promoting comparability between accounting periods rather than expensing the entire cost upfront.

Revenue recognition principle

In the accrual method of accounting, the revenue recognition principle says that revenue should be recognised when it is earned, not necessarily when cash is received. For instance, if a company allows customers to buy on credit, revenue is recognised when the service is provided or the product is delivered, creating both revenue and an accounts receivable.

Matching principle

The matching principle is a fundamental accounting guideline concerning accounting periods. It requires that expenses should be recorded in the same period as the corresponding revenue. For instance, the cost of goods sold (COGS) should be reported in the period when the revenue from those goods is recognised.

In the case of depreciation mentioned earlier, spreading the expense over multiple periods aligns the use of fixed assets with their revenue generation capacity. If a company were to expense the entire cost of an expensive machine in the year of purchase, it would mismatch expenses with revenue over its useful life. Instead, spreading the expense over the asset’s useful life ensures a better match between expenses and the revenue generated.

Example of accounting period

Let’s consider a short example of a monthly accounting period for a small business, XYZ Services:

During January, XYZ Services provides consulting services and invoices clients for £10,000.
Incurs monthly operating expenses, including rent and utilities, totaling £5,000.

At the end of January, the financial summary for reporting purposes is:

This represents a snapshot of XYZ Services’ financial position for the specific month of January. The company will repeat this process each month.