Question

The following statement is an excerpt from the FASB pronouncement related to interim reporting. Interim financial information is essential to provide investors and others with timely information as to the progress of the enterprise. The usefulness of such information rests on the relationship that it has to the annual results of operations. Accordingly, the Board has concluded that each interim period should be viewed primarily as an integral part of an annual period. In general, the results for each interim period should be based on the accounting principles and practices used by an enterprise in the preparation of its latest annual financial statements unless a change in an accounting practice or policy has been adopted in the current year. The Board has concluded, however, that certain accounting principles and practices followed for annual reporting purposes may require modification at interim reporting dates so that the reported results for the interim period may better relate to the results of operations for the annual period.

Instructions

The following six independent cases present how accounting facts might be reported on an individual company’s interim financial reports. For each of these cases, state whether the method proposed to be used for interim reporting would be acceptable under generally accepted accounting principles applicable to interim financial data. Support each answer with a brief explanation.

a) J. D. Long Company takes a physical inventory at year-end for annual financial statement purposes. Inventory and cost of sales reported in the interim quarterly statements are based on estimated gross profit rates, because a physical inventory would result in a cessation of operations. Long Company does have reliable perpetual inventory records.

Short answer

It is acceptable under GAAP.

Step-by-step solution

Meaning of FASB

FASB is a private-sector body tasked with establishing and improving financial accounting standards. The SEC is in charge of establishing accounting rules and standards, but it has mainly left the FASB to develop its own.

Explaining whether it is acceptable under GAAP or not

For interim reporting purposes, using gross profit rates to estimate the cost of products sold is appropriate as long as the technique and rates used are fair. The approach used and any major revisions resulting from reconciliations with yearly physical inventory should be disclosed.