Accounting Periods is the length of time between the Closing the Books in order to prepare the Financial Statements. There are three (sometimes four) Periods of interest in most businesses; the fiscal year, the quarter, and the month. In some highly volatile businesses, the fourth Periods — the week — may be of interest.
The duration depends on how frequently you want to see your Financial Statements. Assuming you want The Balance Sheet And The Income Statement on a monthly basis your Accounting Periods will be one month long and at the end of each month, you will get a set of Financial Statements for the month. At the end of the quarter, you will get two sets of Financial Statements, one for the last month of the quarter and one for the quarter as a whole. At the end of the year, you will get three sets of Financial Statements, one for the last month of the year and one for the last quarter of the year, and one for the year as a whole.
Some businesses dealing in fresh commodities; wholesale meat, produce and fish, for example, are so volatile that the owners can be broke on Monday, millionaires on Tuesday, and broke again on Thursday. (I think this might be a slight exaggeration — but you get the point.) If your business is that volatile you may want to prepare Income Statements on a weekly basis.
Another exception to the month, quarter, year concept can be found in management accounting for a project-oriented business. For example a homebuilder, a shipbuilder, or a movie studio. In these cases, it makes more sense to set up each group of homes, each ship, or each motion picture as a separate entity and do the Profit & Loss on completion of the project. If this applies to your business you need to create detailed project budgets with time and money milestones before you start on a project and monitor your actual progress against your expected progress. If not you may get a nasty surprise at the end of the project.
If your business is based on projects that are started and completed in different years you should stick to the month, quarter, year Periods in order to satisfy the IRS and use Accrual Basis Bookkeeping.
Psuedo Accounting Periods vs. Real Accounting Periods
Even with a computer system Closing the Books and running Financial Statements is a lot more work than you either want to do or pay to have done. So, when it makes sense to have statements prepared more often than you can afford you need what I call —- Psuedo Accounting Periods! At the end of a real Accounting Periods, you formally close the books, prepare the Trial Balance, make all of the adjusting entries, make all of the closing entries, verify that everything is correct and then at long last, you run the statements.
At the end of a Psuedo Accounting Periods, you simply run the statements. You skip all of the rest. The benefit of the Psuedo Accounting Periods is that you can get the data you need to run your business in a timely manner. Instead of waiting several weeks to find out how you are doing, you can quickly determine if things are going well or poorly at the end of every week — or even at the end of every day if that is meaningful.
Selecting Accounting Periods
- Your selection of Accounting Periods depends on two things:
- Whether or not you are using a computer for bookkeeping
- The nature of your business
If you are using a computerized bookkeeping system to keep your books and the system allows you to generate statements at will you are free to use the Psuedo Accounting Periods I just described? If not you are probably stuck with the monthly cycle. In my opinion for most businesses, a quarter is too long to go without Financial Statements.
The nature of your business should be the major determining factor in your choice of Accounting Periods. If you are building homes, ships, or motion pictures each project should be treated as a separate business activity and the Management Accounting Periods should begin with the project and end when the project is completed. (This means two sets of books, one for management purposes and one for financial purposes — the IRS, your lenders, and your investors.)
If you are running a retail store with a computerized bookkeeping system I believe you should run a set of “Pseudo Financials” on a weekly cycle. Otherwise, you will be comparing 4-weekend months to 5-weekend months — and in retail that doesn’t work too well.
Financial vs Management Accounting
Financial accounting is based on a set of conventions established by the IRS, lending institutions, and large investors. Their use enables those who established the conventions to compare businesses in order to determine which ones are reporting spurious results and to have a common standard applicable to businesses in widely diverse fields.
Management accounting is based on providing you with the information you need to run your business. Unlike financial accounting which is based on reporting what happened in prior accounting Periods management accounting deals with both the present (inventory levels) and the future (cash flow projections) so that you don’t get blindsided by unanticipated events.
Both have their place in the scheme of things. Financial accounting satisfies the perceived needs of the outsiders who have an interest in your business while management accounting satisfies your needs as the operator of the business.
The Bottom Line
The duration of your Accounting Period should be dictated by the nature of your business. If it makes sense to use weekly Periods instead of the traditional month — do it!
Immediately at the end of the Periods run a “Pseudo Accounting” set of financials to give you a rough idea of how you did instead of having to wait several weeks to get the polished and finished financial statements.
In my opinion, the nature of your business, not convention, should dictate the length of your accounting Period.